Let’s Twist Again?
By: Andrew J. Willms
President and CEO of The Milwaukee Company
Federal Reserve Chairman Jerome Powell said Thursday that inflation is likely to pick up in the weeks ahead, but not to the point where the Federal Reserve will have to abandon its plans to keep its target rate near zero for the foreseeable future. The chairman added that reopening the economy “could create some upward pressure on prices.”
The recent steepening of the yield curve, where longer-term rates are rising faster than shorter-term ones, has led to rumors on Wall Street that the Fed is planning to reintroduce a policy of buying short-term Treasuries and using those funds to finance purchases of long-term bonds. The policy, commonly referred to Operation Twist, was last employed in 2011, when the Fed bought $667 billion in short-term Treasury debt and used the proceeds to acquire long-term government bonds.
The Fed currently is buying $120 billion a month in Treasuries and mortgage-backed securities, and currently has more than $1-trillion worth of Treasury bills with a maturity of one year or less on its balance sheet. It also holds an additional $1.8 trillion in Treasuries with maturities of one to five years. Pushing down long-term rates would make mortgages, car loans, and other long-term debt less expensive for consumers, which in turn would stimulate consumer spending. As a result, the Twist is bullish for stocks.
It’s no surprise that Powell’s latest speech triggered a sell-off on Wall Street, with the Nasdaq falling into correction territory after dropping by over 2%. Bond prices fell, too, as the 10-year Treasury yield climbed to 1.54% following his comments.
The negativity extended to Thursday’s Treasury auction for $62 billion in 7-year government bonds, which attracted the weakest demand in more than a decade, and tailed by 4.2 basis points, the most in the auction's history. (The tail is the gap between the highest yield the Treasury sold in the auction and the yield before the auction began).
Chairman Powell has consistently said his focus is fulfilling the Fed’s dual mandate of controlling inflation and promoting employment. “Today we’re still a long way from our goals of maximum employment and inflation averaging 2% over time,” Mr. Powell said on Thursday. But it’s clear that the central bank cannot ignore what is happening in stock and bond markets indefinitely.
The market did not get the reassurance from Chairman Powell it was hoping for. To the contrary, it seems the Fed is not particularly concerned about rising interest rates and falling stock prices – for now.
This Week’s Market Commentator’s Podcast attorney Maureen O’Leary and I discuss the Democrats proposals to raise estate, gift taxes and capital gain taxes, and share our thoughts on steps you may want to take before these changes become law. You can listen in on our discussion on Spotify HERE or on YouTube HERE.