David Lerner Associates: What Is "Operation Twist"?

David Lerner Associates: What Is "Operation Twist"?

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2013-01-09

Over the years, the investing world has come up with some unique and creative names to describe various investment and economic scenarios. A “dead cat bounce,” for example, is a short-lived stock market rally that isn’t able to sustain its momentum.

Another creative name that you may have heard recently is “Operation Twist.” This refers to a current Federal Reserve monetary policy in which the Fed purchases long-term bonds and sells short-term bonds in an effort to bring down long-term interest rates and stimulate economic growth. Originally taken from the 1960s-era Chubby Checker song “The Twist,” Operation Twist describes the visual effect that this monetary policy should have on the shape of the yield curve.

“The Fed’s purchase of long-term bonds should help drive their prices up and their yields down, since the price and yield of bonds move in opposite directions,” explains David Lerner Associates High Yield Bond Fund Manager, Douglas Revello. Simultaneously, its sale of short-term bonds should result in the opposite: lower prices and higher yields. “When combined, these two actions will twist the shape of the ends of the yield curve,” says Revello.

Operation Twist was initially instituted by the Fed in 1961 in an effort to stimulate the economy at that time. More recently, the Fed has instituted Operation Twist again over the past year in response to continued sluggish growth in the U.S. economy.

The current Operation Twist has been implemented in two parts, with the first running between September 2011 and June 2012 and the second running between July and December of 2012. The first phase involved the redeployment of $400 billion in Federal Reserve assets, while the second phase redeployed $267 billion in Fed assets.

According to Revello, the ultimate goal of Operation Twist is to lower long-term bond yields. “This would make loans less expensive, thus helping stimulate economic activity like home and automobile buying among consumers and business borrowing among entrepreneurs for expansion, growth and hiring.”

Operation Twist is actually the third in a series of major monetary policy moves conducted by the Fed in response to the 2008 financial crisis. First, the Fed cut short-term interest rates to effectively zero percent. But this left no room for further rate cuts, so when this failed to stimulate the economy adequately, the Fed embarked on a series of steps known as quantitative easing (or QE) beginning in November of 2008.

QE is the purchase of longer-dated U.S. Treasuries and mortgage-backed securities by the Fed in an effort to put more money into the hands of banks to lend to businesses and spur more hiring and economic activity. The first round of QE was followed by QE2, which ran between November 2010 and June 2011 and involved the purchase of another $600 billion in short-term bonds by the Fed.

With economic growth still slow, the Federal Reserve announced another round of quantitative easing, or QE3, on September 13. The Fed stated that this round would be open-ended—or in other words, that QE3 would continue until an improvement in the labor market “is achieved in a context of price stability.”

Material is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. (DLA).

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Founded in 1976, David Lerner Associates is a privately-held broker/dealer with headquarters in Syosset, New York and branch offices in Westport, CT; Boca Raton, FL; Teaneck and Princeton, NJ; and White Plains, NY. For more information contact David Lerner Associates 1 877 367 5960 http://www.davidlerner.com

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