Fed Tries Feng Shui on Yield Curve

The myth that the Fed still had lot of tools to deploy to help an ailing economy suffered a setback this week when it announced Operation Twist.

The idea that moving from short term debt to long term debt while not increasing the size of its balance sheet is somehow “stimulative” is comical. I suppose that it preserves the notion that the Fed has not given up and that somehow folks should be hopeful and spend and invest may be of psychological value but as policy this is nearly useless. To me it has little more effect that had Bernanke rearranged the pens on his desk.

The shape of the yield curve is not what’s stalling GDP growth.

The entire economy is lacking confidence. Businesses and investors are doing little innovative and the consumer is still afraid about his job, the value of his home and the amount of his debt.

Confidence in the ability of the government to help is near zero. I do not see the President, Congress or any of the Republican candidates as having any solutions. People lack confidence because no current leader engenders it in the way that Clinton or Reagan did.

Worse yet, business and banking are both behaving conservatively. Banks are afraid to lend and businesses are afraid to expand. Uncertainty abounds. Banks have decreased commercial and real estate lending and dramatically cut interbank lending. What asset classes have they increased? Treasury/Agency securities and cash – not exactly the formula for growth. In fact, an ideal formula for stagnation.

The Fed also announced that it would take the payments and payoffs on its mortgage portfolio and pump those dollars back into Fannie & Freddie mortgage bonds rather than Treasuries. This will provide more demand for agency paper and help keep mortgage rates low.

Operation Twist will create lower Treasury yields and mortgage rates but it will not do jack for the economy.