After two days behind closed doors, the Federal Open Market Committee made a market-moving announcement: The Federal Reserve is expanding its “Operation Twist” by $267 billion. This is on top of the $400 billion in short-term Treasury bills that the Fed began selling in September. The Fed is also pushing back its June 30 expiration date to the end of 2012.
In a nutshell, what the Fed is doing is selling short-term securities and buying long-term securities instead. What this does is that it flattens the yield curve and lowers long-term interest rates to incentivize borrowing. Now, while this has the unintended consequence of saturating the Treasury bond market, this is great news for Corporate America. That’s because many corporations are taking advantage of the situation and borrowing on the cheap bond market so they can aggressively buy their stock back.
Additionally, the stock market’s higher dividend yields continue to entice investors away from bonds and into the stock market. As investors return to stocks for yield, we should see continued strength in high dividend yielding stocks.
So initiatives like Operation Twist are great news for Wall Street. However, the major indices closed slightly down yesterday—but that’s not a reaction to Operation Twist. Rather, investors reacted to the news that the Fed now thinks that the U.S. economy will expand anywhere from 1.9% to 2.4% in 2012. This is down from its earlier projection of 2.4% to 2.9%. Additionally, the Fed cut its 2013 and 2014 forecasts as well.
As for the next round of Quantitative Easing, that’s still up in the air. Quantitative Easing (QE) differs from Operation Twist in that the Fed outright buys more bonds, expanding the Fed’s holding of assets. This tends to have a bigger impact on the yield curve. Now that the Fed seems to be responsible for job growth in addition to controlling interest rates, economists think that it’s likely. To date, the Fed has purchased $2.3 trillion and government and mortgage-related bonds.