in Between Days: The Fed’s “Significant Downside Risks”

by CC September 22, 2011 12:47 am • Commentary

It seems like markets reacted more to the language in the Fed’s “Operation Twist” announcement than the operation itself.


The Federal Reserve will replace $400 billion of short-term debt in its portfolio with longer- term Treasuries in an effort to reduce borrowing costs further and counter rising risks of a recession.

The central bank will buy securities with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less, the Federal Open Market Committee said today in Washington after a two-day meeting. The action “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the FOMC said.

Chairman Ben S. Bernanke expanded use of unconventional monetary tools for a second straight meeting after job gains stalled and the government lowered its estimate of second- quarter growth. Yields on 30-year Treasuries fell below 3 percent for the first time since 2009 and U.S. stocks had their biggest drop in a month on the Fed’s plan, dubbed “Operation Twist” after a similar Fed action in 1961.

“There are significant downside risks to the economic outlook, including strains in global financial markets,” the Fed statement said. By contrast, the August statement said only that downside risks had increased and omitted any mention of financial markets.


The Fed didn’t disappoint market expectations, but initial equity market reaction was still negative, probably because the Fed statement referred to “significant downside risks to the outlook”. The Fed is doing what it can to address those risks – and we think that sooner or later it will do more quantitative easing – but it doesn’t have any tools that can magically re-ignite economic growth. The “twist” might keep ten-year rates 10-20 basis points below where they otherwise might have been, but interest rates are already extremely low. A few more basis points lower does not transform the outlook. And the biggest risks right now, in Europe, are ones that only European policy-makers can address. –Nigel Gault, IHS Global Insight

The three dissents (same as in August) mean nothing for policy at this point, and it means nothing for QE down the road if Bernanke wants it. Consensus is nice, not necessary. This is Bernanke’s Fed, his legacy, and he intends to make good on his pledge that the Japanesification “cannot happen here.” This meeting provided more proof of that. If he fades his colleagues, trust me, he will fade the Republicans. He doesn’t want another term, he wants to control his legacy. We suspect we will get even more proof down the road. –Eric Green, TD Securities

Why is the Fed bothering? Will these policy shifts boost real economic activity and lower the unemployment rate? It is debatable, but the FOMC majority likely believes that (1) such programs keep financial conditions easier than they otherwise might be; (2) the costs of doing something are low (i.e., inflation risk is muted); and (3) doing something is better than doing nothing in the current environment. –Dana Saporta, Credit Suisse Securities

The decision to reinvest principal payments on agency debt and agency mortgage-backed securities is notable since many FOMC members view Fed policy in this area as quasi-fiscal in nature and directed credit. Therefore, we take the decision to remain involved in the mortgage finance market as an indication that committee members are worried about the state of mortgage finance and the housing sector in light of the slow growth and elevated risks to the outlook. –Michael Gapen, Barclays Capital

The size and length of the twist program implies monthly purchases of $50 billion (over the 8 month period). The combination of MBS purchases and the extension of the average maturity of the Fed’s portfolio should provide more support than anticipated for the housing market. –David Resler, Nomura Global Economics


Japanese stocks fell amid signs of growing instability in the global financial system after the Federal Reserve said there are “significant downside risks” to the U.S. growth outlook and Europe’s risk watchdog said threats to the region’s banks have increased “considerably.”


Here’s where Operation Twist is helping the most so far:

The 10-year Treasury note ended trading today yielding 1.871%, the lowest since the 1940s.

The 30-year note is still far from its record low, but isn’t far away.

At about 3%, the 30-year bond yield is still about 50 basis points above the record low hit in December 2008. The last time the 30-year yield fell below 3% was back in January 2009. The Fed’s twist is likely to push it toward that level in coming weeks, traders say.

LA Times

The Federal Reserve’s latest economic-stimulus move tells the markets one thing loud and clear: The Fed wants mortgage rates under 4%, and soon.

The central bank, in its post-meeting statement Wednesday, committed to shifting its $1.66-trillion Treasury bond portfolio more toward long-term bonds in an effort to bring down longer-term interest rates in general, including on mortgages.

Policymakers also threw the mortgage market another bone: The Fed said it would use the proceeds from maturing securities in its $885-billion mortgage-backed-bond portfolio to buy more of the same.

Until now, the Fed has been using those proceeds to buy Treasury bonds.

The shift back to mortgage bonds could bring $20 billion or more a month of Fed buying power into that market, said Walter Schmidt, a bond market analyst at FTN Financial in Chicago.

The announcement triggered a new rush of buying in mortgage securities. That should translate into lower rates quoted to home buyers and people hoping to refinance.

“It’s absolutely clear they’re targeting mortgages,” Keith Gumbinger, a principal at mortgage data firm HSH Associates in Pompton Plains, N.Y., said of the Fed.

Hewlett-Packard: Worst Board Ever?

The directors of Yahoo have been trashed up and down for their various stumbles, including a rejected takeover by Microsoft and this month’s awkward firing of CEO Carol Bartz.

But let’s not overlook the stumbles of their fellow board members just a 10-mile drive away, at Hewlett-Packard.

The H-P board has see-sawed from one valuation-sucking scandal to the next in the last half decade.

Tomorrow’s Tape: Big Claims


  • 8:30 a.m. ET: Weekly jobless claims are due. Economists don’t expect them to fall much after a big jump to 428,000 the prior week.
  • 10:00 a.m.: The Conference Board’s leading indicators are due. Leading indicators from August. Due on Sept. 22. Meh?


  • Discover Financial Services
  • CarMax
  • Cintas
  • FedEx