Operation Twist fails to satisfy US and Asian markets
Thursday, 22 September 2011 10:29
US and Asian stock-markets have registered their disapproval of the Federal Reserve’s policy initiative – Operation Twist – by falling in value.
The Federal Reserve made no change to interest rates but did issue a statement warning of the difficulties facing the US economy.
The statement said: "Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. There are significant downside risks to the economic outlook, including strains in global financial markets."
After the announcement yesterday, the Dow Jones fell by 2.5 per cent and in late trading in Japan, the Nikkei index was down by more than two per cent.
The Federal Reserve announcement yesterday detailed plans to sell $400bn worth of bonds that mature within three years and buy longer-term debt. The strategy aims to keep long-term interest rates low to encourage mortgage and business lending.
Operation Twist is where the Federal Reserve buys long-term bonds, which increases their price, resulting in a lower yield.
The reaction from analysts was fairly negative with many expecting to see a further round of quantitative easing (QE) instead. The consensus was that the wrong policy initiative had been enacted.
Paul Ashworth at Capital Economics said: "The cost of borrowing simply isn't the problem. Businesses don't have the confidence to invest and half of all mortgage borrowers don't have the home equity needed to refinance at lower rates."
The Federal Reserve intends to buy by end of June 2012 $400 billion of 6-30 year treasuries and will reinvest the principal of mortgage dent in agency MBS.
The Federal Reserve announcement said that the long term rate of inflation remains stable but that unemployment is likely to rise over the coming months and the decline gradually.
There were three members of the Reserve who voted against the policy action.
The Federal Reserve had three or four different options. Some traders were hoping that they would do nothing and that the fact that any potential changes would be off the near-term agenda would be a secure signal to the markets in itself.
Other options, apart from Operation Twist put forward by some commentators were to cut the rate of reserves or increase the size of the government’s balance sheet.
The interest surrounding this announcement by the Federal Reserve from politicians is causing some controversy. The Republican Party has insisted that there should be no further stimulus injected into the economy and the party has been criticised for attempting to influence the Federal Reserve.
The Republicans believe that any artificial stimulus introduced by the Federal Reserve could cause fluctuations in the economy. After the Federal Reserve introduced QE2 last November the Republicans accused them of destabilising the dollar.
The Federal Reserve said last month that it plans to keep interest rates close to zero until at least mid-2013. This was the first time that the Chairman of the Federal Reserve had set out an expected end date on interest rates.
Meanwhile earlier in the day ratings agency Moody’s cut the credit rating on three American banks. First of all, the Bank of America, then Wells Fargo and Citigroup had their ratings cut.
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