Operation Twist is a federal reserve monetary policy involving buying and selling of bonds in an effort to push down the interest rates on mid term and long term interest rates. In Operation Twist, the Federal reserve sells the short term or mid term treasury bonds and uses the cash to buy the long term treasury bonds thus generating demands and reducing the interest rates.
In bond markets, when there is a demand for bonds the interest rates are low and vice versa. The term Operation Twist was named after the Chubby Checker song and was first tired in the 60’s. The name comes due to the graphical representation it has on the yield curve. A typical yield curve has a linear upward sloping yield. The Operation Twist’s actions aims to twist the end of the yield curve which gave rise to the term Operation Twist.
Operation Twist was announced in early September 2011 when the Federal Reserve decided to intervene in the markets to sell $400 billion of short term securities. Operation Twist was originally used to describe the plan that was implemented in 1961 by the then Kennedy administration and the Federal Reserve. The Operation Twist basically aims at reducing interest rates in an effect to boost borrowing and spending during weak economic times. Since lower interest rates affect mortgage rates and business loans, the purpose is clear, which is to encourage borrowing and this boost the economy.
During May earlier this year, St. Louis Fed President James Bullard noted that the Operation Twist would end on its original schedule of June 2012, which was recently extended to run through December 2012 with an additional $267 billion.
How does Operation Twist work
Under the Operation Twist program, the Fed sells short term Treasury securities that it owns and buys the long term bonds that typically have a maturity period of six to 30 years. By reducing the interest rates, investors usually shift their money to the stocks as investments in the Treasury bonds would now offer lower yields. By investing into mortgage backed securities, the Fed basically aims at lowering the housing market rates which are then passed on by the banks to potential home owners.
Mortgage backed securities are basically asset backed securities representing claims on the cash flow from mortgage loans through a process that is known as securitization.
Operation Twist is not aimed to inject cash into the markets but is primarily aimed at reducing the interest rates and is quite different from Quantitative Easing.
Critics of Operation Twist
Critics state that the Operation Twist requires more than necessary intervention from the Federal Reserve even as past studies sgugest that Operation Twist has minimal effect where in, in the past Operation Twist managed to reduce the borrowing costs only by 0.15%. Experts continue to question the effectiveness of Operation Twist as interest rates have been kept at record lows since 2008. However, it is not entirely possible to weigh in on the effectiveness of the program.