Operation TWIST again: Quantitative Tightening

Operation TWIST Again: Quantitative Tightening
Sep 6, 2010 6:14 AM
Shalom Hamou

Via

Having been an attentive Fed Watcher for the last 25 years I have a great experience of the way they communicate or intervene on the markets. Although most of the time they are careful to make themselves predictable every 4 to five years they do engineer some change in market direction or so they wish.

When doing that they communicate or intervene on the market below (when market is falling) or above important technical levels in order to blow the shorts or longs out of the water which amplifies their actions. Their interventions are brutal and they don't let the market breath which make them easily predictable.

Although long term prediction is child play short term prediction (over one day, one week, one month or one year is almost impossible.) When, since May I could make easily short term market predictions and be right 100% of the time it raised my eyebrows and I concluded that there was some kind of government interventions on the market. This is why I came to discover the content of that article.

The name Operation TWIST Again comes from an operation very similar to Quantitative Easing engineered by the Federal Reserve System in the 60's, called Operation TWIST, which ended in a resounding failure and the panic abandon of the gold standard in 1971.

Operation TWIST: To Boldly Go Where We Have Gone Before: Repeating the Interest Rate Mistakes of the Past by Adam M. Zaretsky of the Federal Reserve Bank of St. Louis.

Content:

We are all focussed on Quantitative Easing as the only Monetary Tools of the Federal Reserve System. I was fooled at first too. Then I found out that this fuss about the Fed buying less and less security at a time when the offer from the Treasury is thinning made me thing again and if the FEd just reversed course to make us believe it succeeded and change our expectation, what the average opinion expect the average opinion to be:

At Jackson Hole Bernanke said;

"Market expectations for continued accommodative policy have in turn helped reduce interest rates on a range of short- and medium-term financial instruments to quite low levels, indeed not far above the zero lower bound on nominal interest rates in many cases."

He also said, and at first I didn't quite believe him.. and I was wrong:

"The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do. As I will discuss next, the issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool."

All that fuss about making the market expect higher yields was in fact intended.

The answer is simple: instead of making the yield curve go down to meet the required demand make that demand go up to meet the yield curve.

Making borrowers run after the growing yield the Fed expects to generate a volume of demand sufficient to create growth.

Quantitative Easing Against Quantitative Tightening:

Although Quantitative Easing is not a Stimulus per se because if it worked those enticed to lend money would lose because of an increase in the long-term rate and they would also lose if it didn't work because borrowers would default. It is a lose-lose proposition.

Quantitative Tightening is more like a Stimulus: if the Federal reserve can entice a sufficient number of borrowers by crating an artificial scarcity then all the borrowers would win.

The problem is that if the borrowers are not in the market for enough credit to jump start the economy all those potential winners become a bunch of losers and the economy loses too.

Lenders lending at a high yield would also win as a the same time the risk of default falls dramatically.

Nuclear Weapons:

As the Federal reserve System has accumulated $2 Trillions of long-term fixed rate assets they own a weapon of mass destruction as they can at any moment decide to dump them on the market.

It is not the Chinese that could dump their US Treasury Bonds and Notes but the Federal Reserve System. Bond holders would become the collateral damage of a friendly fire!


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