Like they did last summer: Fed may ‘Twist’ again

WASHINGTON, Wed Jun 13, 2012 – It has become a familiar choreography for the Federal Reserve: Officials ease monetary policy, and the economy improves. Then conditions weaken, reviving debate about the need for further stimulus.

The central bank again finds itself at that difficult juncture heading into a meeting next week. As Europe’s banking crisis intensifies and the labor market sputters, the Fed appears increasingly likely to offer more monetary stimulus – despite political opposition, internal reticence and concerns about whether it will be effective.

Given an outlook that is weak but not recessionary, the Fed could opt for the relatively low-hanging fruit of extending “Operation Twist,” its effort to drive down long-term borrowing costs by selling short-term securities to buy longer-term ones.

Another relatively costless tool it could employ would be to push official guidance for when overnight interest rates are likely to rise, now set at late 2014, even further into the future.

Many believe that with government bond yields already near record lows as investors flock to safety, an extension of Twist, which is due to expire at the end of the month, or even outright bond purchases, might not do much good.

Atlanta Federal Reserve Bank President Dennis Lockhart, who has argued that the bar for further monetary support remains high, captured the sentiment while speaking to reporters this week.

“In some respects the market has been doing the job for the Federal Reserve of suppressing the longer-term rates,” he said.

But a growing chorus of economists, both within and outside the Fed, say the central bank cannot sit idly by with the U.S. unemployment rate still at an elevated 8.2 percent – and showing few hints of falling.

They argue for an extension of Twist if not a further expansion of the Fed’s balance sheet through bond purchases, a policy known as quantitative easing.

“It’s not about lowering the long-term rate it’s about getting people to believe in growth,” said Michael Dueker, a former St. Louis Fed economist now at Russell Investments.

Part of the idea is to get businesses to spend some of the cash they are sitting on by giving them confidence in the recovery. That in turn should bolster employment, and make Americans more comfortable about their finances.

“It’s a signal from the Fed that they’re not going to let the economy stagnate,” said Dueker.

The Fed, which meets on June 19-20, has held overnight interest rates near zero since December 2008 and has bought $2.3 trillion in securities in two separate bouts of quantitative easing, or QE.

It then launched a $400 billion Operation Twist. The Bank for International Settlements estimated in March the policy would have a similar effect on 10-year Treasury yields as the second round of QE, potentially lowering them by about 0.85 percentage point.

Rates on the benchmark 10-year Treasury slumped to a record low of 1.442 percent on June 1, after the weak May payrolls data. Mortgage rates are also at their lowest ever, with a 30-year fixed mortgage available for less than 4 percent.