EC It’s Time To Do The Twist Again

“Come on let’s twist again, Like we did last summer!
Yeaaah, let’s twist again, Like we did last year!” 

– Chubby Checker

During the last half of 2020, bond yields were flat-lining at historically record low yields. The message was clear: bond investors did not fear inflation. The tone changed abruptly in early January when the ten-year U.S Treasury yield rose above 1.00% in yield. In February, five-year Treasury yields crossed 0.50%, which raised alarms for global investors.

Despite stock market trepidation over rising yields, the Fed remains calm. It appears some Fed members are applauding higher yields. The following four comments came from three Fed members on February 25, 2021, the day in which the five-year Treasury notes gapped higher by 25 bps.

  • Jim Bullard: “The rise in bond yields is a good sign so far.”
  • Esther George: “Long tern yield rise doesn’t warrant monetary response.”
  • Raphael Bostic: “I am not worried about move in yields.”
  • Raphael Bostic: “(The Fed) doesn’t need to respond to yields at this point.”

Quite often, Fed members make statements that turn out to be not so true. We believe the comments above fit this bill.

The Fed is keenly aware rising interest rates will choke off the fledgling economic recovery. The possible solution to halting rate increases and keeping the recovery rolling dates back to the 1960s when Chubby Checker and the Twist were all the rage.

In this article, we dissect Operation Twist. We also look back at Operation Twist 2.0 circa 2011/12 and assess its effectiveness and how it impacted various asset classes.

Note: We brought up Operation Twist a month ago in:  Can The Fed Both Tap On The Brakes and Floor The Gas? At the time, we thought Operation Twist might alleviate coming irregularities in Treasury issuance.

The Twist 1.0

The Fed introduced Operation Twist 60 years ago (1961) under pressure to spur economic activity. At the time, the dollar was pegged to gold which limited the Fed’s options. Lowering interest rates would have weakened the dollar and led to the withdraw of gold by foreign nations.

To stimulate economic activity and avoid losing gold, the Fed devised Operation Twist. Under the plan, the Fed buys longer-term securities, similar to QE, however, they do not print reserves. Instead, they fund the purchases by selling shorter-term securities. Given the Fed’s balance sheet or money supply wouldn’t change, it was hoped the actions would not weaken the dollar.

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William K. 4 weeks ago Member's comment

Thanks for a well written and educational article. At least I learned from it, hopefully others more involved also learned.

Vivian Lewis 4 weeks ago Contributor's comment

we can learn from history. what a splendid article!