Why Traders Booed the Fed's "Operation Twist' - And You Should, Too

With "Operation Twist," U.S. Federal Reserve policymakers are attempting to use an old strategy to launch a new attack on the wheezing U.S. economy.

But the assault, announced after the central bank's Federal Open Market Committee (FOMC) meeting concluded yesterday (Wednesday) afternoon, isn't expected to have much long-term success.

"The way [Fed policymakers] handled this proves that the Fed doesn't have much power left," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "It tried to use big sweeping statements, and careful language ... and it still didn't work - the market sold off ... and traders [on the trading floor in New York] actually booed. They don't want this ... they know it's bad."

As many expected, the central bank will use a derivation of a 1960 s initiative that's designed to "twist" the interest-rate "yield curve" by flattening it out. Between now and the end of June, the Fed will buy $400 billion worth of bonds with six-year to 30-year maturities while selling an equal amount of shorter-term debt with three -year maturities.

The Fed intended to rally markets with a sign of reassurance, but stocks failed to reverse their declines. The Dow Jones Industrial Average nose-dived 284 points, or 2.49%, the Standard & Poor's 500 Index skidded 2.94%, and the tech-laden Nasdaq Composite Index slumped 2.01%.

The market consensus: "Team Bernanke" has again made a move that will do more long-term harm than good to the U.S. economy.

The "Operation Twist" Form of Stimulus

In its post-meeting statement, the central bank said it expects the new "Operation Twist" program to "put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative."

Yields on 10-year Treasury notes slipped after the Fed announcement to a new record low of 1.8482%, according to FactSet Research. That's 10 basis points below the 1.94% yield before the FOMC meeting. Yields on 30-year bond fell 14 basis points, reaching to 3.07% - the lowest since January 2009.

With "Operation Twist," the objective is to get corporations to spend some of their cash hoards, and push investors out of safe-haven U.S. Treasuries and into stocks.

"They're literally trying to force scared consumers and scared investors into the market," said Money Morning's Fitz-Gerald. "They're trying at the same time to free up that logjam of funds that corporations are, in fact, sitting on."

The Fed also announced plans to reinvest maturing mortgage debt into mortgage-backed securities (MBS) instead of Treasuries, and reiterated its policy to keep the target range for the federal funds rate near zero.

But Fitz-Gerald said such stimulus measures have never helped the economy in the long-term.

"Long-term implications haven't changed ... we still have lots of problems here," said Fitz-Gerald. "The economic system is very different from the market system, and that's the underlying issue here. The Fed has been wrong about this all along. And what it's doing now proves that it's still wrong."

Bernanke felt pressure to announce some form of stimulus, especially since the nation's economy looks worse today than it did on Aug. 9, when central-bank policymakers last met. Bernanke yesterday cited high unemployment, a disappointing increase in household spending and a depressed U.S. housing sector as the reasons for more stimulus.

In addition, the International Monetary Fund (IMF) on Tuesday downgraded its U.S. growth forecast to 1.5% from 2.5%.

But with little success from the Fed's previous measures, there's not much optimism "Operation Twist" will be any different.

"We expect the Fed's actions to have very little visible effect on the economy, because the level of interest rates and the shape of the curve are not the key constraints on growth," wrote Ian Shepherdson from High Frequency Economics. "Mr. Bernanke wants to be seen to be doing something, but his hand is not on the fiscal policy lever."

Dissent Within the FOMC

Yesterday's Fed decision passed with a vote of seven to three. Philadelphia Federal Reserve Bank President Charles I. Plosser, Dallas FRB President Richard Fisher and Minneapolis FRB President Narayana Kocherlakota all voted against the Fed's action.

"The fact that there were three dissensions is very, very serious - one or two, that's fine ... but an FOMC with three dissensions, well, that's very, very serious," said Fitz-Gerald. "This shows that more members are trying to distance themselves from Bernanke."

Indeed, the sign of a divided Fed can trigger market anxiety just as easily as a weakening economic recovery.

"The one thing that weighs on any decision here is that we are still seeing dissenters in the Fed. And that doesn't bode well for a stable recovery," said Carl Larry, director of energy derivatives and research at Blue Ocean Brokerage.

Congressional Republicans have also spoken out more against the Fed's actions.

In a letter to Bernanke on Monday, Senate Republican leader Mitch McConnell, R-KY, Sen. John Kyl, R-AZ, House Republican leader Eric Cantor, R-VA, and Speaker of the House Sen. John Boehner, R-OH, asked the Fed chief to refrain from implementing more stimulus measures. They said there's no evidence quantitative easing has helped the economy.

"We submit that the Fed should resist further extraordinary intervention in the U.S. economy, particularly without a clear articulation of the goals of such a policy, direction for success, ample data proving a case for economic action and quantifiable benefits to the American people," the letter said. "We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy."

The Republicans said consumer confidence and worker innovation should be driving the U.S. economy, not Federal Reserve policy.

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