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Operation Twist

Operation Twist
InvestingBondsFixed IncomeFixed Income Essentials

What Is Operation Twist?

Operation Twist is a Federal Reserve (Fed) monetary policy initiative utilized in the past to bring down long-term interest rates to further stimulate the U.S. economy when traditional monetary tools were missing by means of the timed purchase and sale of U.S. Treasuries of different maturities.

The term gets its name from the simultaneous buying of long-term bonds and selling short-term bonds, suggests a "twisting" of the yield curve and creating less curvature in the rates term structure.

Understanding Operation Twist

The name "Operation Twist" was given by the mainstream media due to the visual effect that the monetary policy action was expected to have on the state of the yield curve. On the off chance that you visualize a linear upward inclining yield curve, this monetary action effectively "twists" the closures of the yield curve, thus the name Operation Twist. To put it another way, the yield curve twists when short-term yields go up and long-term interest rates drop simultaneously.

The original 'Operation Twist' came to fruition in 1961 when the Federal Open Market Committee (FOMC) sought to strengthen the U.S. Dollar (USD) and stimulate inflows of cash into the economy. At this time, the country was still recuperating from a recession following the finish of the Korean War. To promote spending in the economy, the yield curve was flattened by selling short-term government debt in the markets and utilizing the proceeds from the sale to purchase long-term government debt.

The operation depicts a form of monetary policy where the Fed buys and sells short-term and long-term bonds relying upon their objective. Nonetheless, dissimilar to quantitative easing (QE), Operation Twist doesn't extend the Fed's balance sheet, making it a less aggressive form of easing.

Market turmoil in mid 2021 has filled speculation that the Fed could involve Operation Twist without precedent for almost a decade.

Special Considerations

Recall there is an inverse relationship between bond prices and yield — when prices go down in value, the yield increases, and vice versa. The Fed's purchasing activity of long-term debt drives up the price of the securities and, thus, diminishes the yield. At the point when long-term yields fall faster than short-term rates in the market, the yield curve flattens to reflect the more modest spread between the long-term and short-term rates.

Additionally note that selling short-term bonds would diminish the price and, consequently, increase the rates. In any case, the short finish of the yield curve in view of short-term interest rates is determined by expectations of the Federal Reserve policy, rising when the Fed is expected to raise rates and falling when interest rates are expected to be cut.

Since Operation Twist includes the Fed leaving short-term rates unchanged, just the long-term rates will be impacted by the buy and sell activity conducted in the markets. This would make long-term yields decline at a higher rate than short-term yields.

Operation Twist Mechanism

In 2011, the Fed couldn't reduce short-term rates any further since the rates were at that point at zero. The alternative then was to bring down long-term interest rates. To accomplish this, the Fed sold short-term Treasury securities and bought long-term Treasuries, which forced the long-term bond yields downward, thereby boosting the economy.

As short-term Treasury Bills (T-Bills) and notes matured, the Fed would utilize the proceeds to buy longer-term Treasury notes (T-notes) and bonds. The effect on short-term interest rates was negligible as the Fed had committed to keeping short-term interest rates close to zero for the next two or three years.

During this time, the yield on 2-year bonds was close to zero and the yield on 10-year T-notes, the benchmark bond for interest rates on completely fixed-rate loans, was exclusively about 1.95%.

A fall in interest rates reduces the cost of borrowing for organizations and people. At the point when these entities approach loans at low-interest rates, spending in the economy increases and unemployment falls as organizations can reasonably secure capital to extend and finance their projects.

Highlights

  • Operation Twist is a monetary policy strategy utilized by central banks pointed toward stimulating economic growth through bringing down long-term interest rates.
  • Operation Twist was first attempted in 1961, and again soon after the 2008-09 financial crisis.
  • This is accomplished by selling close term Treasuries to buy longer-dated ones.
  • Operation Twist effectively "twists" the closures of the yield curve where short-term yields go up and long-term interest rates drop simultaneously.