Tuesday, September 6, 2011

Operation Twist? What The Hell Is That?

"A socialist eventually runs out of other people's money" -  Margaret Thatcher

Someone asked me what the hell Operation Twist was this morning.  It's essentially one of the Fed's "tools" that it thinks it can use to try and stimulate the economy by making a concerted attempt to lower medium/long term interest rates and stimulate housing and business borrowing.  The way it works is the Fed will attempt to "flatten" the Treasury yield curve by going out and buying up Treasury bonds in the middle and long part of the Treasury curve (5-30 years, mostly in the 7-10 range where mortgage rates are based). 

In researching the topic in order to make sure I wasn't oversimplifying or erroneously describing what it is, I googled the term and came up with an interesting link about Operation Twist from Nowandfutures.com which attributes this "Operation Twist" idea back to the Kennedy Administration and its desire to get interest rates lower in order to lower the balance of payments deficit at that time.  Here's the essay for those interested in the historicity of fiat currency and Government/Fed intervention in the markets:  LINK

In a "twist" on the methodology used by the earlier Fed, which sold short term Treasuries and bought long term Treasuries, I'm surmising that the Fed this time around will try to pull down interest rates and flatten the curve solely by buying the longer paper.  I say this because it already has in place a zero-interest short term rate policy thru 2013, and thus I do not expect the Fed to be unloading short term paper. You will hear some fancy lingo like "increase the duration" of the Fed's Treasury portfolio, which simply means the Fed is letting the shorter term holdings mature and it's rolling that money into intermediate/long Treasuries.

Does this mean that it's time to buy longer-maturity Treasuries?  No.  Like any other publicly traded market, the information that the Fed will likely do this is largely already priced into the market.  Don't you think, given the amount of "telegraphing" that's been done on this - and the fact that Pimpco's Bill Gross has said he may buy intermediate Treasuries after dumping all of his Treasuries six months ago - that the big institutional money has already anticipated the Operation Twist event?  In fact, this will be a money-losing trade for the Fed/Taxpayer because, in all likelihood, we are at the bottom of this secular interest rate cycle and at some point the price/yield of Treasury bonds will reflect the true rate of inflation and dollar devaluation that is coming. 

Moreover, the Chinese and other big Treasury holders will likely use the Fed bid as an opportunity to dump big blocks of their holdings into the market, as they continue to make good on their publicly stated promise to diversify away from holding U.S. dollars.

I'm assuming the inquiry referenced above occurred because someone received a call from either their broker or their genius financial advisor who said now is the time to buy longer-maturity Treasuries in order to pick up some extra interest income and take advantage of the highly anticipated Operation Twist implementation.  Sorry, it's too late.  If your broker tries to sell you an intermediate Treasury ETF like TLT, hang up.  If your financial advisor tries to convince you to buy Treasuries, tell him to move you into cash so you can move your account to someone who understands gold.  Be careful because this Fed operation will be a marketing tool used by brokers to try and generate commissions.  By the time retail brokers/advisors are trying to unload ideas on the public, it means the parent financial firm has already positioned the security and is now looking to book profits via the retail distribution network (brokers/advisors).

Circling back to the original question leading to this blog post, this is how I answered:

"Operation twist" is an attempt by the Fed to lower medium/long term interest rates by pegging the short term rate to zero and then going out and buying longer-date Treasuries. It's meant to be an extension of QE2 and supposedly can be implemented without the Fed having to expand its balance sheet (printing money). It's called a "twist" because the yield curve is normally upward sloping - i.e. the longer the maturity of Treasury bond, the higher the yield. But the idea is that the Fed can "twist" the yield curve into a "flatter" shape.

What's going to happen next? 1) Obama announces a $1 trillion infrastructure spending program. 2) Obama also announces that the Govt will use Fannie Mae and Freddie Mac to refi $1 trillion in troubled mortgages at 4%.  3) It just so happens that the Fed has $1 trillion in FNM/FRE mortgages. Those get refi'd and moved back to the FNM/FRE/Taxpayer balance sheet and it enables the Fed buy $1 trillion in longer-dated Treasuries to try and lower rates.  4) The Fed at its next meeting Sept 21-22 announces some sort of new QE. My bet is they need to inject massive liquidity into the collapsing banking system and will buy more crap assets from banks and the Fed will also need to expand its balance sheet to pay for Obama's new spending program.

Obviously it won't unfold exactly like that but that's the basic format and Obama and the Fed have already telegraphed something like that. For example take Obama's speech to the huge crowd of welfare/union entitlement recipients in Detroit yesterday and assume that's what he's going to announce Thursday night while most of us click the cable box between the NFL season opener and the U.S. Open tennis tournament. The Fed will have to come up with a way to pay for Obama's program and that will happen at the FOMC meeting.

Gold and mining stocks are going to be volatile BUT they are going to go a lot higher within the next month or two.


  1. Dave,
    The reason for this question this morning, I have heard this mentioned
    a few times by the Feds butt boys at cnbc. Again this morning.

  2. (Dave)

    Hey Bill! LOL. I just added that part because I like taking a shot at moronic brokers and financial advisors any chance I get. No doubt brokers/advisors will use this as pitch to create activity...

    That CNBC is broadcasting it, at least 4-6 weeks after most good blog sources have picked up on it, tells you that it's likely a done deal.

    10-yr Treasuries hit a record low at one point today, which tells you the market is already pricing this thing in.

    It won't do anything to stimulate the housing market because most people who can qualify for a mortgage already are stuck in a house. Plus mortgage rates have been at near-record lows for quite some time and mortgage purchase applications have been trending lower all year.

  3. Dave, I hope you comment on the Swiss Franc.

  4. (Dave)

    Hey Roger. Thanks for asking my view on that. When I saw it first thing this morning on my laptop in bed I was already composing a blog post. But then I figured enough other commentators would have something to say.

    Having said that, all Switzerland did - and has been doing for several months - is effect a currency deval just like every other big economic country, only they have done it in a short period of time. The U.S. has been slowly devaluing its currency since 1971 (over 80% since 1971, something 96% since the founding of the Fed - I believe those numbers can be found on the Fed's website).

    All the Swissies did was further confirm the Von Mises proposition from 1936 in which he said that global system of fiat currencies would eventually end up in a devaluation race.

    You can't do this in a currency system anchored by gold. It's really kind of a "prisoner's dilemma" of sorts, if you recall that idea from your Econ 101 class in college. I don't blame the Swiss, all they did was join in the currency wars with a big splash. At least they announced their intention rather than continuously regurgitating up this "the U.S. has a strong currency policy in place" bullshit that we've been getting from Geithner...

    It also further confirms the bull market in gold/silver is still young and has long way to go.

  5. Thanks for your thoughts, Dave. I appreciate your view. I hadn't thought of it as one quick deval vs. a gradual deval. For some reason, I considered the Swiss Franc pseudo sound money and the next best thing to silver an gold. Not anymore.

    Occasionally, I think I may have too much invested in gold and silver. I think I should diversify more and hold some foreign currencies. Today was one of those days I realize that I made the right choice with gold and silver. I was reminded of a gal I dated back in my 20s. There was an energy and excitement about her, but something just didn't feel right about it, so I went off in another direction. Every once in a while, I would think about her and wonder if I made the right decision. A few years ago I ran into her and she was real thin, looked strung out on drugs, and was with a real creepy guy. Yep, I made the right decision all right. Kinda like the Swiss Franc. Just toss it in the can with the rest of the paper fiat currencies.

    I actually lived in Denver for many years. Over by the DU campus near Evans and York St. I graduated from UCD. I miss Denver and Colorado a lot. I hope to get back there for good. Perhaps one day my lady and I will fill up our car with our gold and silver and head back to Colorado.

    Keep up the good work. You rock Dave.

  6. Talking about etfs ...there's more than meets the eye with these instruments.

    First HFT, Now ETFs: The SEC Slowly Wakes Up From Its Slumber

    Heaven forbid the SEC finally comprehend that ETFs, especially those favored by HFTs, are nothing but the latest iteration of synthetic (squared/cubed) CDOs, whose purpose is simply to wag the do, courtesy of massive leverage, which makes the underlying impact by the moves in the synthetic.

    Of course, should the SEC actually do something about ETFs, that will make Larry Fink very angry. And the last thing the SEC wants is to anger the guy who runs Wall Street from the shadows.

    Which simply means that like with everything else, the best resolution is not an attempt to intervene, which will inevitably fail, but to let Wall Street finally cannibalize itself: a process which will also coincide with the much overdue Great Reset, which we have been since inception, is the only possible resolution to to the dead end Western society finds itself in currently.

    "SEC officials are zeroing in on "leveraged" ETFs, which amplify investor bets, often through derivatives. Derivatives are financial contracts with values linked to another asset. The funds typically offer double or even triple the return of an index, such as the Standard & Poor's 500-stock index." Soon enough, we dread to think, the SEC may also realize that it has absolutely no clue about market topology and structure, nor how anything actually works in modern markets.


  7. (Dave)

    Thanks for the feedback Roger - appreciate it. Good analogy between the gal you dated and the swissy. I live near the DU 'hood - I'm in Wash Park - I sneak onto the DU tennis courts occassionally.

    Re your gold/silver allocation: I have 90% of my net worth in the metals/mining stocks. Embry and Eric Sprott say they have the same % (multiples greater than mine lol).

    The thing is, we KNOW that every paper currency is devaluing and EVERY single country has the same fundamental problems as the U.S. Even Canada and Australia, which are currencies some people ask me about. The swiss took their currency off the gold standard many years ago. If you google it you can find the exact date. At that time it no longer became a flight to safety currency. Yet, many people still think of it that way. Incredible how power "perception" is, huh? The big Swiss banks are in as bad of shape or worse as the U.S. too big to fails. There's no reason to invest in "Switzerland" any more than there is to invest in the "U.S.," which means staying away from the piece of paper which represents the national stock - the currencies.

    If it is not obvious by now, it should be -an attempt by the Central
    Banks of the West to derail the rise in the gold price is currently

    I mentioned in my midday comments that an effort would take place to
    prevent gold from moving beyond $1900 in an attempt to paint a double
    top on the daily price chart and induce a round of technically related
    selling from speculators on the long side.

    This effort can clearly be seen in the following ONE MINUTE BAR CHART
    which reveals an enormous spike of 4,000+ contracts in the middle of
    the evening during a time period in the gold trading not normally
    known for this sort of volume. The question must now be raised - if
    this was a hedge fund blowing out of a long gold position, why wait
    for such a low liquidity environment in which to execute to trade
    knowing full well that by so doing, one would be guaranteed the worst
    possible exit price for the trade. Also, since the price of gold has
    been RISING and NOT FALLING, why would any gold long be forced to
    unload a position. It certainly is not under any duress from price
    We can probably eliminate this as the cause therefore since only the
    rankest of fools would attempt such a thing.

    The next question that must then be raised is if this were a hedge
    fund doing the selling to establish a fresh short position, why would
    they sell in such size at such an hour guaranteeing themselves to be
    filled with a fresh short position at the worst possible price by
    selling into a hole? The logical answer is that they would not do such
    a thing.


  9. WARNING (updated)
    Wednesday, September 7, 2011 at 9:13 am

    I think it's quite clear now why gold responded yesterday in the opposite direction from what you would have expected. With central banks actively managing a debasement of their currencies, we are now seeing them also attempt to actively manage a debasement of gold, too. Be careful. Be very careful.

    Yes, that's 7,000 contracts (700,000 ounces) (nearly 22 metric tons!) dumped on the Globex while London and NY are closed! This should also raise your deja vu spidey senses regarding silver in May. The $ drop in silver was greater because the silver market is considerably smaller. However, it's the same strategy. Maximize the downward impact and collateral damage by executing the attack at a time of minimal liquidity.


  10. (Dave)

    nothing new there - been dealing with Fed/ECB manipulation of gold for the 10 years i've been doing this.

    i would like to correct the writer there, it's WESTERN central banks, not global CB's. and what is different right now is that the cliff-dive attacks get bought by asia/india/et al. in the past you would get two full weeks large red candlesticks almost every day. now we get those for a day or two and then consolidate rally.

    bring it on Bernanke!!!!!