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The Return of Chubby Checker? Will the Fed Twist Again?

Posted on September 21st, 2011 | Author: Robert C. Gabrielski

The Fed is wrapping up its two-day meeting today. This unusual meeting follows last month’s Fed meeting in Jackson Hole, Wyoming, where Fed Chief Bernanke felt that the Fed Board needed two days to consider its remaining options available to stimulate the U.S. economy.

At this point, the Fed has limited tools available.  The Fed has already implemented a couple rounds of Quantitative Easing (QE 1 and QE 2) and is searching for any economic tools that it can use to stimulate the economy and induce businesses to spend money and hire employees.  Will the Fed twist again like it did in ’61?

Here’s the simple twist:  (i) the Fed sells short-term bonds, and (ii) uses those funds to buy long-term bonds.  The monetary goal is to raise short-term interest rates, which are already at historical lows, and reduce long-term interest rates, essentially by “twisting” the yield curve.  The economic goal is to stimulate the economy and create jobs.  Will reducing the long-term interest rate really have any impact, particularly because the yield on Treasury Ten-Year Notes hovers just below two percent as of this post?  How much must the Fed spend on this dance to have any material impact?  The experts are all over the board on that question, ranging from US$20B to US$500B.

Economist Martin Feldstein argues that QE2 led to a rise in the stock-market in the second half of 2010, which in turn contributed to increasing consumption and the strong performance of the U.S. economy in late-2010.  Will the same take place with the twist? Early market reports show that the U.S. Dollar is gaining strength in anticipation of the Fed starting its dance.  Stay tuned as the Fed is expected to make its announcement at 2:30 PM New York.