Very important point from Goldman’s Dominic Wilson on yesterday’s “Twist” announcement. Essentially he argues that the part of the operation where the Fed is going to sell $400 billion of short-dated bonds is irrelevant. Only the buying part really effects anything:
Despite the discussion of whether QE3 will follow, for all intents and purposes, QE3 has already begun with yesterday’s shift. While the Fed has been careful to frame the latest shift as a “twist” that leaves its balance sheet neutral, as we have described before the policy is conomically more or less equivalent to outright asset purchases. This is because the decision to sell short-dated securities in exchange for bank reserves – the additional transaction relative to the prior purchase program – is largely irrelevant given that the two are very close substitutes when interest rates at the front end of the treasury curve are close to zero (the US 3-year yield is only about 35bp). So yesterday’s policy announcement is not materially different in conomic terms from an announcement to buy $400bn of longer-dated USTs through “printing money”. And in fact, given the tilt towards longer durations, the size of purchases is not meaningfully different from QE2.
As for why markets have reacted to negatively:
But the darker possibility is that markets are becoming more worried about the capacity of policy to affect the outlook. Since the asset markets themselves are part of the mechanism by which unconventional policy should operate, there is some circularity to that view. We wrote last week about the limits of central banks (Global conomics Weekly, September 14th) t they may lack the boldness to act, particularly given the backlash to their current policies, but also that fiscal policy may be a more effective instrument at this point.
Read more: http://www.businessi…9#ixzz1YggPV8f7