Extending Twist to sell 4-year debt or buying mortgage bonds are options
By Deborah Levine, MarketWatch
NEW YORK (MarketWatch) — Treasury prices declined on Wednesday, pushing yields up to their highest in about a week, as traders were less certain than usual about what to expect from the Federal Reserve’s policy meeting.
Yields on 10-year notes 10_YEAR +2.77% , which move inversely to prices, rose 4 basis points to 1.66%, their highest since June 12. A basis point is one one-hundredth of a percentage point.
Yields on 30-year bonds 30_YEAR +1.39% increased 4 basis points to 2.77%.
The Federal Open Market Committee will end its two-day meeting and release a statement at 12:30 p.m. Eastern time. After that, officials will release revised forecasts and Fed Chairman Ben Bernanke will hold a press conference beginning at 2 :15 p.m. Eastern.
The most common prediction from analysts is that the Fed will continue its bond-purchase program known as Operation Twist. Other possibilities are outright buying of more bonds — a strategy known as quantitative easing — or making bigger changes to the language of its statement. Read recent story on Fed expectations.
“We can’t recall a FOMC meeting where the divergence of potential outcomes has been so wide,” said bond strategists at Nomura Securities. “Although Twist extension is a common theme, nobody has much insight into that other than it seems like the easiest to do.”
Continuing Operation Twist would have very different effects on shorter-term maturities (which the Fed would continue to sell) and longer-dated ones (which the Fed would continue to buy). So the decision could cause the gap between long-term and short-term rates to either shrink (flattening the so-called yield curve) or expand (steepening the curve).
“Should the Fed extend Twist, the details are clearly important. Size and length of operation, conditionality, whether they buy long Treasury paper only or include [mortgage-backed securities], and the range of possibilities makes it difficult to handicap the possible moves in advance,” said Richard Gilhooly, U.S. director of interest-rate strategy at TD Securities. “We think the bulk of positions have been moved to flat curve risk and outright risk.”
Selling 4-year notes?
There’s also some debate what may happen with intermediate-term debt. Up to now, the Fed’s Operation Twist has involved selling its holdings of debt maturing in three years or less 3_YEAR +2.04% . If it wants to stick with that, it only has about $200 to $300 billion left to sell, analysts said.
If it feels the need to buy more than that in longer-term debt (generally defined as maturing in 7 to 30 years), it could opt to sell its holdings of debt maturing in up to four years. That would give it much more firepower, but analysts say that risks causing further disruptions in consumer credit — since many loans are based on 5-year maturities.
”The risk is of an expansion of the sales window to the 4-year sector,” said Ajay Rajadhyaksha, head of U.S. fixed income and securitized products strategy at Barclays Capital. “This can be hedged by being long the market, in our view, as in this scenario, the Fed will also need to put $350 to $400 billion to work.”
Deborah Levine is a MarketWatch reporter, based in New York.
