History Shows Promise for ‘Operation Twist’

by Dan Wiener | September 26, 2011 11:55 am

At the end of its two-day confab last week, the Fed said that — as expected — it would shift $400 billion of its enormous bond holdings from short-term to longer-term Treasuries in the hopes of knocking rates down further and stimulating the economy in what some are calling “Operation Twist.”

Have we heard this record before? In one way — yes, of course. But like many cover songs, this one comes with a different beat. Rather than spending new money, the Fed will sell short-term bonds (which should push yields higher) and buy longer-term bonds (which will push yields lower), flattening the yield curve. They don’t plan to do anything with their mortgage bonds other than to reinvest the interest and/or returned principal received on them.

For some historical perspective, it was more than 50 years ago that the Fed first put needle to vinyl on “Operation Twist.” In that version, which debuted in February 1961, the Fed initiated a similar strategy of selling short-term bonds and buying longer-term bonds. There still is some debate about how effective the measure was, but the Dow was up 7% a year after the policy took effect and up 50% four years later.

Wall Street’s immediate reaction to the Fed’s move was to pout — and then came the rout. Traders took the Dow down about 100 points following the Fed announcement, hesitated, then kept selling. At market’s close, the Dow had fallen 284 points, or 2.5% on the day.

Thursday was even more extreme, with the Dow dropping another 391 points, or 3.5%, on recessionary fears sparked by weak data out of China and Europe. While all of the major indices were in the red on the day, Wall Street was picking losers and big losers, with energy and precious metal stocks taking the biggest hits, while health care and consumer goods and services stocks saw more modest losses.

But the market began to pick itself up Friday, with the Dow gaining around 200 points, or 1.9%, from Friday’s open to about midday Monday.

Still, it has been only five days since Operation Twist was announced — it’ll take a lot longer before we can measure its full effect.

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