History Shows Promise for ‘Operation Twist’

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 dont 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 Streets
immediate reaction to the Feds 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 markets 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 Fridays open to about midday Monday.
Still, it has been only five days since Operation Twist was announced itll take
a lot longer before we can measure its full effect.