Active Operation Twist / “Operación Twist” Activa

Genevieve Signoret

Earlier, we laid out six options before the Fed, one of which was called “Operation Twist”.

Restructure the balance sheet (“Operation Twist”): Replace short-term securities with longer-term ones, to depress long-term interest rates.

We said that the Fed could implement Operation Twist in one of two ways:

• It can do so passively, by using funds from the $20bn it receives each month in principal payments;
• Or actively, selling short-term securities to buy longer-term ones.

On September 21, the Fed opted for Operation Twist of the active variety:

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.

Unfortunately, Infosel tweeted that day that the Fed had announced $400 billion in securities purchases, failing to add that they would also sell the same amount in short-term securities. People who don’t follow these matters closely may have been misled into thinking that the purchases expanded the Fed’s balance sheet. In fact, it merely restructured it.

We did not expect the Fed to purchase maturities all the way up to 30 years. Neither did markets.

The Fed announced, additionally, that it will reinvest principal payments from the agency bonds and mortgage backed securities on its balance sheet purchased in its first round of quantitative easing, QE1:

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.

“Agency debt” are bonds issued by government agencies such as Fannie Mae and Freddie  Mac. These agencies raise money through bond issues to buy up mortages, which they then securitize in agency mortgage-backed securities (MBS). During QE1, the Fed bought both. Now it will use principal payments from maturing bonds and  MBS  both to buy up more MBS. By raising demand for MBS, it keeps the mortgage market liquid. The hope is that this will exert downward pressure on mortgage rates, which should translate to upward pressure on demand for housing, and thus their prices.