In Between Days: The Federal Twist

by CC September 20, 2011 11:58 pm • Commentary

Tomorrow’s Tape: All About the Benjamin (Bernanke)


  • 10:00 a.m. ET: The nation’s realtors let us know about existing home sales in August. Economists expect a small gain, reversing a decline in July.
  • 2:15 p.m.: The main event: The FOMC decision is due. Black smoke means Operation Twist, white smoke means everybody gets a free car. I’m hoping for the white smoke.



After a choppy morning, stocks built up a head of steam that lasted most of the day, with the Dow gaining almost 150 points at the session high.

But then the rally ran out of gas. Investors awaited the latest affirmation out of Greece that all is well, but nothing concrete was forthcoming as the latest talk with the Troika produced only vague headlines about plans for more meetings.

Industrials, materials and consumer discretionary stocks withered and end with the largest declines.

The Dow gained just 7.65 to 11408.66, after earlier climbing as high as 11550. The Nasdaq fell 0.9% to 2590.24, and the S&P 500 ends 2 points down at 1202.09.


After rallying early on in the day on Tuesday, the S&P 500 peaked just below its 50-day moving average and finished at the lows of the day.  Downtrends in the market are often characterized by rallies that fail at or near key moving averages like the 50-day, so bulls are hoping that today’s pullback is not the start of a longer term trend.


Evangelos Venizelos, the Greek finance minister, and the so-called troika debating funding for Greece concluded a conference call late on Tuesday, with lead negotiators set to return to Athens early next week in the clearest sign yet they are about to sign off on an €8bn aid payment to the debt-ridden country.

The European Commission said “good progress” was made in a teleconference between Athens and negotiators from the European Commission, the International Monetary Fund and the European Central Bank, which was aimed at reaching an agreement over a set of measures to allow the release of the next bail-out tranche to Greece.

The full mission is expected to come back to Athens early next week to resume the review, almost three weeks after leaving the Greek capital.

The Greek finance ministry said in a statement that satisfactory progress had been made. It added that technical discussions concerning the 2011 and 2012 budgets, as well as the 2013-2014 period, would continue in Athens in coming days.

Discussions will also continue this weekend at the annual IMF meeting in which Mr Venizelos is taking part, the ministry said.

Greece does not face an imminent risk of default since it has no major bond redemptions due in coming weeks but may have difficulties paying full salaries to civil servants and pensions if it does not get the €8bn tranche. It is estimated the state will run out of money around mid-October. It is noted it already owes more than €6bn to private companies and individuals.

Seeking Alpha

On Monday morning CNBC reported that in a survey the network had conducted, 70% of respondents predicted that the Federal Reserve would undertake an ‘Operation Twist’ in the near future.

Further, almost 80% of respondents who predicted Operation Twist believed that the Fed would act this week.

The Federal Open Market Committee (FOMC) is set to meet on Tuesday for the start of a special two-day meeting. If the Fed decides to roll out Operation Twist this week, the FOMC meeting may be the most likely time.

In the 1960s, the Fed conducted the original Operation Twist, and many are assuming that the Fed would follow a similar strategy now as back then.

Under the original Operation Twist, the Fed purchased long-term bonds in an effort to drive down long-term interest rates, rather than drive down shorter-term interest rates.

To drive down longer-term interest rates, the Fed may target a specific security.

Which longer-dated security would the Fed target? One possibility may be the 10-year.

The interest rate on the 10-year is typically used to set rates on various consumer loans, including mortgage rates. A lower 10-year rate may support a recovery in the housing market and help to reduce unemployment in the broader American economy.

Still, interest rates are at a historic low, as the yield on the 10-year remains near 2%. Would lowering the interest rate more make a noticeable difference?

Further, are market participants able to accurately predict the moves of the Fed?

Back in June, Bloomberg conducted a survey of foreign exchange professionals that found that nearly 2/3 of them did not believe the Fed would engage in a third round of quantitative easing (QE3).

Thus far, that prediction has proved accurate, as the Fed has not engaged in a third round after the second round concluded back in June. Still, an Operation Twist would in a way be a modified version of a QE3, as it may amount to the Fed purchasing more treasurys.