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Bernanke’s Twist Called Symbolic as Europe Rules: BGOV Barometer

July 2 (Bloomberg) -- The impact of Federal Reserve Chairman Ben S. Bernanke’s latest addition to his record monetary stimulus, intended to boost demand for risky assets, is so far difficult to discern in stock and bond markets.

The BGOV Barometer shows yields on the benchmark 10-year Treasury note have climbed and inflation expectations have declined since June 19, the day before the Fed announced it would extend its Operation Twist program and swap $267 billion in short-term securities with longer-term debt through December. Even with last week’s rally, the Standard & Poor’s 500 Index of stocks is little changed from June 19.

Moves in global markets have been driven by economic data and developments with the sovereign debt crisis in Europe, making it “very difficult” to determine the impact that Operation Twist is having, said John Lonski, chief economist at Moody’s Capital Markets Group in New York.

The S&P 500 climbed 2.5 percent on June 29, its best performance since Dec. 20, after European leaders reached an agreement that alleviated concern banks will fail. The index fell 0.17 percent on June 20, the day the extension of Twist was announced.

“The market is still very much wrestling with the implications of the lack of resolution to what’s happening in Europe,” Lonski said. Operation Twist “is more symbolic than anything else in terms of effect.”

Substitute Securities

Bernanke called the extension of Operation Twist a “substantive step” on June 20 and said it works by lowering interest rates and inducing investors to buy “substitute securities” to replace the holdings acquired by the Fed. The S&P 500 ended last week just 0.3 percent above its June 19 level. Yields on the 10-year benchmark Treasury note have risen 3 basis points to 1.65 percent since June 19.

Robert Eisenbeis, chief monetary economist at Sarasota, Florida-based Cumberland Advisors, said in a June 21 report that since the Fed began Operation Twist “uncertainty and perceived risks were as important or more important” than the Fed’s purchases in impacting borrowing costs as investors adjusted their holdings based on the sovereign debt crisis in Europe and the outlook for the U.S. economy.

Inflation expectations have fallen since the Fed announced its latest effort at boosting growth. The break-even rate for five-year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable maturity Treasuries, was 1.73 percentage points on June 29. The rate, a measure of the outlook for consumer prices over the life of the securities, has fallen from 1.88 points on June 19. The Fed has an inflation target of 2 percent.

While the extension of Operation Twist may not have sparked a market rally, the announcement still does provide some support for risky assets by showing the central bank is willing to ease further, Lonski said. The FOMC said June 20 it is “prepared to take further action as appropriate” to boost growth and ensure “sustained improvement” in the jobs outlook.

“It definitely has had the effect of underpinning investor confidence in the willingness of the Fed to respond quickly to any further weakening,” Lonski said.

To contact the reporter on this story: Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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