What is Operation Twist?
Operation Twist is a strategic initiative by the Federal Reserve designed to lower long-term interest rates in an effort to stimulate the U.S. economy. This becomes particularly important during times when traditional monetary tools fall short. This initiative utilizes the timed purchase and sale of U.S. Treasuries of different maturities.
The term arises from the simultaneous buying of long-term bonds and selling of short-term bonds, effectively ’twisting’ the yield curve and smoothing its curvature.
Key Takeaways
- Operation Twist stimulates economic growth through the lowering of long-term interest rates.
- This is achieved by selling near-term Treasuries to buy longer-dated ones.
- The policy ’twists’ the yield curve, with short-term yields rising and long-term interest rates falling simultaneously.
- Initially implemented in 1961 and reintroduced after the 2008-09 financial crisis.
Visualizing the Twist
The mainstream media coined the term ‘Operation Twist’ due to its effect on the yield curve’s shape. Visualize a naturally upward-sloping linear yield curve; Operation Twist changes this shape by increasing short-term yields while decreasing long-term interest rates. This visual ’twist’ is why the strategy earned its name.
The original initiative in 1961 responded to the U.S. recovering from a post-Korean War recession. The Federal Open Market Committee (FOMC) aimed to bolster the U.S. dollar and boost economic cash flow by selling short-term government debt and using those proceeds to buy long-term government debt.
Unlike quantitative easing, Operation Twist does not expand the Fed’s balance sheet, making it a less aggressive form of economic intervention.
Special Considerations
There’s an inverse relationship between bond prices and yields. If bond prices drop, yields increase, and vice versa. When the Fed purchases long-term debt, bond prices rise, leading to a lower yield. A faster decrease in long-term yields, compared to short-term rates, results in a flattening yield curve.
On the other end, selling short-term bonds lowers their price and increases short-term yields. The slope of the short-term curve reflects expected Federal Reserve policies—rates rise or fall based on anticipated Fed actions. Since Operation Twist leaves short-term rates unchanged, only long-term rates feel the impact of the Fed’s buying and selling activities, causing long-term yields to decrease more significantly.
Mechanism of Operation Twist
In 2011, with short-term interest rates already near zero, the Fed set out to lower long-term rates. They sold short-term Treasury securities and bought long-term Treasuries, thereby pushing long-term bond yields downward to bolster economic activity.
As short-term Treasury Bills (T-Bills) and notes matured, proceeds were redirected to longer-term Treasury notes (T-Notes) and bonds. The short-term interest rates remained less influenced due to the Fed’s commitment to low rates over the next several years.
At this point, yields on 2-year bonds hovered near zero, while the yield on the 10-year T-note benchmark stood around 1.95%.
Falling interest rates reduce borrowing costs for both businesses and individuals. This accessibility to affordable loans translates into increased economic spending and reduced unemployment, as businesses can finance expansions and new projects.
Related Terms: Monetary Policy, Yield Curve, US Treasuries, Interest Rates.
References
- Federal Reserve Bank of San Francisco. “Operation Twist and the Effect of Large-Scale Asset Purchases”.
- Federal Reserve Bank of St. Louis. “Effective Federal Funds Rate”.
- U.S. Department of the Treasury. “Daily Treasury Yield Curve Rates”.
