Today the Fed announced its plan to move its bond portfolio allocation from short terms bonds to longer term bonds. Mainly focusing on the 6 to 30 year range.
The reason they are doing this is to lower long term rates. Typically bond interest rates rise the longer the maturity is. For example, if you go to a bank to put money into a CD, the longer you are willing to commit your money, the higher the interest rate is.
A typical yield curve will look like this:
What Ben Bernanke and the Fed are trying to do is to lower interest rates at the far right side of the curve. Their hope is that this will lower mortgage rates and interest rates on long term loans – helping the housing markets, small business lending, and consumer borrowing.
Why the focus on long term rates? The thinking is that the housing market over the past decade became such a large part of the US economy that it is now holding employment levels down:
The hope is that Operation Twist will lower mortgage rates and increase refinancing and new home purchases. In addition lower long term rates will be helpful to small and large business looking to expand.
The only issue is, too many homeowners are underwater to refinance/move and many business are already sitting on large amounts of cash and not willing to expand in an uncertain economic (and tax) future.
If today’s stock market decline is any indication, investors don’t seem too excited about Operation Twist either.
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