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Let’s Twist Again

The Federal Reserve chooses its words carefully. Last week, officials didn’t say they were worried, or that things are starting to look bad, but they lowered the outlook for growth to 1.9 to 2.4% for this year, and raised the estimate for the jobless rate to 8 to 8.2%. And their actions said something, too. The FOMC announced its 7th policy move since late 2008: it will extend “Operation Twist”, a program that was introduced last fall, and was set to expire at the end of the month. The new ‘twist’ will extend to the end of this year.

The Fed is ‘twisting’ its balance sheet by selling the short-term bonds that it holds and replacing them with longer-term bonds. The result is downward pressure on long-term rates, which is meant to make credit conditions easier.

The first “Operation Twist” amounted to $400 billion of short-term bonds swapped for long-term. The second twist will total $267 billion in long-term bonds by the end of this year…that comes out to $44.5 billion per month.

But the Fed is not adding to its $2.9 trillion balance sheet…it’s just extending the maturity of its balance sheet by swapping an equal amount of bonds, rather than buying more bonds with new money.

While a $267 billion twist might sound like a lot, it’s not going to do much. It will have an impact on the bond market, but it won’t have much of an impact on growth. But the Fed had to be seen doing something, so it took the minimalist approach…at least for now.


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