Round Up: Operation Twist’s Perfect Timing

by JT McGee

Fed enacts Operation TwistThis week the Federal Reserve embarked on a new policy intended to drive down long-term interest rates. Known colloquially as “Operation Twist,” the Federal Reserve will sell off short-dated Treasury securities to purchase long-term Treasury Bonds.

The result is a fundamental change in the Fed’s balance sheet. Previously, the Fed maintained an average maturity date of 6 years on its balance sheet. By dumping short-dated securities and buying on the long-end, the price for money will fall further. The balance sheet’s average maturity date will rise.

30-year Treasury securities now yield less than 3%, closing with a yield of 2.83% on Thursday. Naturally, borrowing costs for any creditworthy borrower will follow. Corporations, which typically earn a 2% risk premium to the risk-free rate, will now be able to borrow (theoretically) at 4.83% for 30 years.

Obviously such a low cost of borrowing at a time of lowly business valuations offers the ability for companies to leverage up, improve their return on equity and purchase competitors as well as vertically integrate suppliers. Lest we not make the same error as Dave Ramsey in his book Entreleadership; there are plenty tax benefits to debt.

The S&P500, which has an average ROE of over 27% and a P/B ratio of 1.82, is on firesale. I mentioned that stocks are cheap—they are—and the next wave of LBO activity is soon to come.

Timing is of the Essence

The Federal Reserve obviously has its own detractors and critics. Operation Twist was timed perfectly, given the political and economic reality. Fears in the Eurozone brought investors back to safety, driving yields down and T-bill prices up. The Fed can now sell its T-bills to scared investors, and buy on the longer end of the curve.

Also, the Fed avoids inflation hawks, who are increasingly concerned that monetary policy measures will stoke inflation. Food and oil, which are included in broad measures of CPI, have dropped in recent weeks, as have the “core” inflation measure components. Given outlook for the world economy, what better time to interject more liquidity into the markets and monetize more debt obligations?

For my generation, this is a boon. For seniors, savers, and those nearing retirement, well, they’re “Royally F***ed.” Welcome to a world where money has no time value—where a dollar in the future is on equal basis with a dollar in hand today. If you aren’t leveraging to the hilt, then the Fed’s operation twist will absolutely burn you in the worst way. If, however, you take the recent action to mean that the Fed will do anything to make the time value of money zero, then you’re going long ANYTHING with Other People’s Money.

This time is never different, but your response should be. Leverage to the hilt—money is free.

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Photo by: I love Butter

{ 3 comments… read them below or add one }

Financial Success For Young Adults September 23, 2011 at 17:51

I’m definitely looking to pick up stocks. If I could buy a few rental properties right now I would, but I think I’ll just take it slow.
Thanks for including my post!


Barb Friedberg September 24, 2011 at 22:54

If you are in your 20’s or 30’s with a good and secure job, now is a great time to invest as much as possible. Some even recommend borrowing to invest on margin. Make sure if you do, you can handle market volatility. Excellent article.


Ben - BankAim September 25, 2011 at 17:33

LOL.. you said it well:

“For my generation, this is a boon. For seniors, savers, and those nearing retirement, well, they’re “Royally F***ed.”

This is going to be great for people buying houses or needing long term loans, but for savers or anyone wanting to make a nice return on their CDs or Savings accounts.. well.. you said it well.


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