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Fed: An encore for the Twist?

By Sheyna Steiner · Bankrate.com
Wednesday, June 20, 2012
Posted: 12 pm ET

The Federal Reserve's rate-setting committee will extend Operation Twist, and the Fed says it still plans to keep a key short-term interest rate at its current level until 2014.

Operation Twist is the nickname given to the Fed's effort to keep longer-term interest rates low. The initiative was set to expire at the end of this month, but it will be extended through the end of 2012. Operation Twist is an easing half-step in which short-term securities already in the Fed's portfolio are swapped for longer-dated securities.

In its announcement, the Fed says: "This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative." The target federal funds rate will remain in a range between zero percent and 0.25 percent, which means that the prime rate will remain 3.25 percent.Federal Reserve building

The rate-setting Federal Open Market Committee's announcement comes in response to the slackening job market and the European debt crisis.

The extension of Operation Twist is less indicative of the Fed throwing the economy a life preserver and more about hedging bets.

"It's part-and-parcel of monetary risk management to do these halfway measures when things start to look a little bit more risky than you would like, but you are not necessarily seeing warning signs flashing in the economy," says Paul Edelstein, director of financial economics at IHS Global Insight, an analysis and forecasting firm.

Operation Twist's limited impact is mostly due to the tumult in Europe. As the crisis across the Atlantic has deepened, safety-seeking investors have bought U.S. Treasuries, sending yields to record lows.

Some mitigating circumstances may give Operation Twist more relevance.

"The Treasury is starting to issue more and more longer-dated securities to lock in rock-bottom interest rates," Edelstein says. "So the Fed doing the Operation Twist does counteract that effect on long-term rates. In this environment, it would have a bit of an impact, but again I think the eurozone safe haven bid will dominate interest rates probably for the rest of the year."

Focus on housing

That the housing sector has yet to recover is a common refrain in statements issued by the Federal Open Market Committee. The rate machinations might be less about buoying the economy and more about keeping housing afloat.

With a lid on long-term interest rates, consumers who qualify can borrow for a song. Mortgage rates have been breaking barriers for months. One of the goals of Operation Twist is keeping mortgage rates low.

If investors were to abandon Treasuries and the Fed were no longer a major buyer, then Treasury yields would rise. That would have implications for individual borrowers and the housing market.

"As soon as people think there is going to be economic growth, the long money is going to sell off, and it's going to undo the quote-unquote 'good' (Federal Reserve Chairman Ben Bernanke's) been doing," says Axel Merk, president and chief investment officer of Merk Investments.

"He wants to make sure that the borrowing costs for homebuyers remain low until at least we've worked through (the foreclosure pipeline), and we can go back to a more normal environment," Merk adds. "I think that any twisting and commitment to keeping rates low is going to reflect that."

Even as the rest of the economy backslid in May, the housing market showed some signs of recovery. On Tuesday, the Commerce Department reported that housing starts were down slightly in May, but applications for permits increased to levels not seen since 2008 and were up 25 percent over May 2011.

Still bad news for savers

Of course, the world is not just cobbled together with houses and mortgages. Other consumer lending and saving products are also affected by the Fed. Rates on auto loans, credit cards, certificates of deposit, and savings accounts are all directly or indirectly linked to movements of the federal funds rate.

Read more about how the federal funds rate affects interest rates on consumer loans and CDs.

While today's low interest rates benefit borrowers, savers continue to suffer from the lack of decent yields, which may come with another set of long-term implications.

"Clearly, Operation Twist -- keeping rates low at the long end of the curve -- drew money into dividend-paying instruments," says Stanley Dash, vice president of applied technical analysis at TradeStation, an online brokerage. "We've seen a lot of emphasis in the press on dividend-paying stocks, and the utilities index has done well, and that is continuing today."

Savers have largely been pushed into taking on more risk as a result of low yields on fixed income and savings vehicles, or they've seen their income fall as a result of sticking to the safer climes of CDs and savings bonds.

Unfortunately, when it comes to bolstering the economy, spending will save the day. Savers are on their own.

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June 23, 2012 at 3:16 am

The Fed's completly out of bullets and Wall Street is so broken that if the Fed would've discountined this at the end of the month and stood on the sidelines the markets would've tanked until they resumed with another ineffective program (QE3). The Fed can use it's power to control inflation and liquidity, job creation is only something the private sector can do. The truth is government stimulis and monetary easing are just masking and prolonging a market correction that will continue until we just let it bottom out. Yes, people will be unemployed, people will lose their house, but isn't this the case already? Government intervention has caused the second wave of crises we've seen since 2008, commondity spikes (energy, food) and sovereign debt crisis (europe, US debt downgrade)

Mortgage Rates
June 21, 2012 at 2:56 am

I like this app and I look take to your future posts on further development. Good luck!

Softball Leagues

June 21, 2012 at 1:19 am

The real funny part of this is these two posts. First, Lee thinks that a bank can control interest rates and home values...If you have equity Lee then I can tell you every bank that has a second mortgage product will 'redo' any second mortgage. Then you have Mike that thinks that banks, a business, will not react to news in regards to actions by the Federal Reserve and the Government...classic!!!

June 20, 2012 at 4:27 pm

Wells Fargo told me in 2007 rates will never go down below 14% I needed a 2nd mortgage now I've been STUCK. Nobody wants to redo a 2nd Mortgage. they lied to me and i will never trust that(We'll Go Far) company again!!

June 20, 2012 at 2:45 pm

funny how rates are to remain low but W ells F argo just raised their rates .25% after hearing the news. more money for them and less for the working man.