Bernanke’s Operation Twist May Be Undermined by Geithner’s Long Bond Sales
The Fed plans to purchase $400 billion of longer-dated Treasuries in a bid to reduce yields. At the same time, the Treasury Department is selling more long-term securities to decrease its reliance on short-term borrowing. That strategy puts upward pressure on interest rates by adding to market supply.
The reason for the conflicting approaches: Geithner wants to reduce the amount of debt that the Treasury has to roll over each month, a task made more urgent after the U.S. was driven to the brink of default in August. Bernanke is seeking to prevent the slowing economy from suffering a Japanese-style lost decade with growth averaging under 1 percent per year.
“The Fed is worried about the U.S. becoming Japan, while the Treasury is worried about the U.S. becoming Greece,” said Louis Crandall, chief economist at Wrightson Plc, whose Jersey City, New Jersey-based company is a unit of ICAP Plc, the world’s biggest broker of trades between banks.
As a result, the central bank’s action may have “a pretty limited effect” on long-term interest rates and the economy, according to James Hamilton, a professor of economics at the University of California at San Diego.
“We shouldn’t have any illusions that it will radically change things in any great hurry as far as the economy is concerned,” said Hamilton, co-author of a paper last year on “the effectiveness of alternative monetary policy tools.”
The Fed said Sept. 21 it will carry out its purchases of $400 billion of Treasuries with remaining maturities of six to 30 years by the end of June 2012. It will sell an equal amount of debt with maturities of three years or less.
The yield on Treasury 30-year bonds was 2.90 percent on Sept. 23 in New York, down from 3.2 percent the day before the announcement. It was down 41 basis points for the week, the most since December 2008.
Bond investors had already anticipated the Treasury’s sales and were reacting to the Fed’s move, as well as increased concern that the world economy is slowing, Crandall said. Yields may have dropped even more if not for the Treasury’s planned sales, Hamilton said.
Treasuries due in 10 or more years have returned 28 percent in 2011, exceeding the 24.4 percent gain in all of 2008, during the financial crisis, according to Bank of America Merrill Lynch indexes. Not since 1995, when the securities soared 30.7 percent, have investors done so well owning longer-dated U.S. government debt.
Most of the gains on long-term Treasuries this year have come since the end of June, with the securities returning 24.9 percent for the biggest quarterly gain since at least 1978, when the Bank of America Merrill Lynch indexes began tracking the debt.
Demand for Treasuries has been fueled by government reports showing the U.S. economy almost stalled in the first six months of 2011 and added no jobs on August, keeping unemployment at 9.1 percent.
Under Geithner, the Treasury has been pursuing a policy of extending the maturity of the government debt outstanding by issuing a greater proportion of longer-dated securities. The average maturity of U.S. debt rose to 62 months in the second quarter of this year from 49.4 in the first quarter of 2009.
The Treasury signaled on Sept. 21 that it will not deviate from that path in the wake of the Fed’s move.
“Our long-standing debt management policy is to finance the U.S. government at the lowest possible cost over time, and that policy is unchanged,” the Treasury said in a statement.
That strategy has been endorsed by the 14-member Treasury Borrowing Advisory Committee made up of banks and bond-market investors, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Pacific Investment Management Co., that the department regularly consults regarding its financing strategies.
Officials have said they would eventually like to extend the average maturity of the debt to between six and seven years.
The Treasury likely will issue about $430 billion of debt with maturities of 10 years or more both this year and next, Crandall said. That would be in line with $433 billion in 2010 and up from $371 billion in 2009.
Chubby Checker Song
The Fed’s strategy to push down longer-term yields has been dubbed Operation Twist after a similar action in 1961 that got its name from a hit song, “The Twist,” by Chubby Checker.
That maneuver lowered longer-term Treasury yields by about 15 basis points, or 0.15 percentage point, according to a 2011 paper by Eric T. Swanson, senior research adviser at the Federal Reserve Bank of San Francisco. The Treasury cooperated with the Fed in 1961 by reducing its issuance of longer-dated debt while the central bank was buying.
“They were both on the same page” back then, Hamilton said. “But in this case the Fed and the Treasury seem to be reading from different scripts of what they are supposed to be doing.”
He said the Treasury should alter its borrowing strategy to bring it in line with what the Fed is doing.
Such a step would run the risk of a backlash by investors who might view it as an abandonment of a prudent financing policy by Treasury, Crandall said.
“Preserving confidence in U.S. debt is one of the most important policy objectives at this time,” he said.
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