What Is Operation Twist?
Let me explain Operation Twist directly: it's a Federal Reserve monetary policy tool I've seen used in the past to bring down long-term interest rates and give the U.S. economy an extra push when standard methods aren't cutting it. This happens through carefully timed buys and sells of U.S. Treasuries with varying maturities.
The name comes from the way it twists the yield curve by buying long-term bonds while selling short-term ones, which reduces the curve's overall slope and flattens the term structure of rates.
Key Takeaways
- Operation Twist is a monetary policy strategy used by central banks aimed at stimulating economic growth through lowering long-term interest rates.
- This is achieved by selling near-term Treasuries to buy longer-dated ones.
- Operation Twist effectively 'twists' the ends of the yield curve where short-term yields go up and long-term interest rates drop simultaneously.
- Operation Twist was first attempted in 1961, and again in the years following the 2008-09 financial crisis.
Understanding Operation Twist
You might have heard the term 'Operation Twist' from media coverage—it's named for the visual twist it applies to the yield curve. Picture a straight upward-sloping yield curve; this policy twists the ends, pushing short-term yields up while pulling long-term rates down at the same time.
The first Operation Twist happened in 1961, when the Federal Open Market Committee (FOMC) wanted to bolster the U.S. Dollar and get more cash flowing into the economy. The U.S. was still shaking off a recession after the Korean War, so they flattened the yield curve by selling short-term government debt and using those funds to buy long-term debt, encouraging spending.
In essence, this operation is a type of monetary policy where the Fed buys and sells short-term and long-term bonds based on their goals. But here's where it differs from quantitative easing (QE): Operation Twist doesn't inflate the Fed's balance sheet, so it's a milder approach to easing.
Important Note on Recent Speculation
Keep in mind that market chaos in early 2021 sparked talk that the Fed might dust off Operation Twist for the first time in almost a decade.
Special Considerations
Remember, bonds have an inverse relationship between price and yield—when prices drop, yields rise, and the opposite holds true. When the Fed buys long-term debt, it pushes those prices up and drives yields down. If long-term yields fall quicker than short-term rates, the yield curve flattens, showing a tighter spread between short and long rates.
Selling short-term bonds lowers their prices and raises their rates. But the short end of the curve is really shaped by what people expect from Fed policy—rates climb if hikes are anticipated, and drop if cuts are on the horizon.
Since Operation Twist keeps short-term rates steady, only long-term rates feel the impact from the trading. This means long-term yields drop faster than short-term ones.
Operation Twist Mechanism
Let's look at how this worked in 2011: the Fed couldn't cut short-term rates anymore because they were already at zero. So, they targeted long-term rates instead, selling short-term Treasury securities and buying long-term Treasuries to push those yields down and help the economy.
As short-term T-Bills and notes matured, the Fed rolled the proceeds into longer-term T-notes and bonds. Short-term rates barely budged since the Fed pledged to keep them near zero for years. At the time, 2-year bond yields were almost zero, and 10-year T-notes—key for fixed-rate loan benchmarks—yielded just about 1.95%.
Dropping interest rates like this cuts borrowing costs for businesses and people. When loans are cheap, spending picks up, businesses expand affordably, and unemployment drops as they fund new projects.
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