How To... Interpret the FOMC 'Twist'

The FOMC decision on interest rates on Wednesday is going to be a rather unique one.  Ben Bernanke cannot really lower rates but it can use its balance sheet that holds so many Treasury and other debt instruments that it purchased during quantitative easing measure.  The expectation is “The Twist,” where the Fed will be able to increase the duration and extend the maturity schedule considerably.

“The Twist” has no official consensus on what this will truly be in dollar terms.  How this duration and maturity gets extended is by the central bank buying longer-dated Treasuries with debt maturing soon and over the next few years.  The Fed can also start selling shorter-dated debt instruments to purchase much longer-dated maturities out in the 7-year to 10-year maturity range.  Some feel that the maturity purchases could be far longer than just the 10-year timeframe.

As far as the size, our expectation is that this could be $300 billion to $400 billion.  That is effectively what it will have in maturities over the next few years.  Here is the catch: Bernanke and friends might not communicate at all what the total dollar amount will be.  We have seen several firms’ research summaries on what to look for.

Bank of America Merrill Lynch has noted that an active Twist would be by issuing 3-year notes and buying more in the 7-year to 10-year maturity ranges.  The firm sees more active buying in the 10-year and longer maturities but the firm sees lower liquidity being an issue there.

Morgan Stanley also sees some activity in the 25-year to 30-year Treasuries but sees the Fed buying more in the 8-year to 10-year segment of Treasuries.

Goldman Sachs sees the Fed selling some of its intermediate notes (up to $300 billion worth) in favor of buying down Treasuries with a 7 year to 30-year horizon.

Technically, this is the ill-fated QE3 that most do not hope for.  How well it works is going to be prodded in the coming weeks and months, but the effort is aimed at keeping longer term borrowing rates lower than they would be without any form of intervention.

JON C. OGG