Let's twist again ... like the Federal Reserve did back in 1961

Julian Harris
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INVESTORS expect the Federal Reserve to pave the way for “Operation Twist” this week, a method of stimulus first used in 1961 that was named after the popular dance.

Markets think the Fed will opt for the Twist instead of steaming ahead with a controversial third phase of quantitative easing, dubbed QE3.

With few signs of further QE to boost equities, the Dow Jones sank nearly one per cent yesterday, as worries over the ongoing Eurozone debt crisis weighed on sentiment.

Equities were also hit by more bickering between senior Democrats and Republicans, with few signs of compromise over how to tackle the country’s mammoth annual budget deficit.

Republican John Boehner rejected President Obama’s plan to raise $1.5 trillion in new revenues: “The government has a spending problem and I don’t believe it makes sense to tax people we expect to invest in our economy,” he said.

American 30-year Treasury bonds rose more than two points ahead of the Fed’s anticipated purchasing of longer-dated securities.

Operation Twist would see the Fed sell shorter-term paper to finance the acquisition of longer-term bonds, in order to hold down long-term yields, with the aim of boosting private sector investment in the economy without having to increase the size of its own balance sheet.

Yields on 30-year Treasuries sank nine basis points to 3.18 per cent after the rumours circulated.

“An active ‘twist’ is the most likely outcome of the meeting, but we think expanding the Fed’s balance sheet would be more effective,” said Jeremy Lawson of BNP Paribas.

“We look for the Fed to adopt a flexible approach committing to a monthly run rate of $55bn, rather than some large upfront sum -- we estimate that Operation Twist could amount to as much as $420bn,” added Société Générale, in a note.

“If the Fed were to commit to maintaining the balance sheet at ‘at least’ the current amount, this would be a strong hint that QE3 would be considered if necessary,” it said.

Speculation over the central bank’s plans surfaced in yesterday’s Wall Street Journal, widely considered to be privy to the Fed’s upcoming announcements.

The Fed’s committee is meeting today and tomorrow, and will officially announce its policy decision tomorrow evening.

• Ben Bernanke is expected to announce Operation Twist, first used in 1961 and named after the popular dance