Monday, April 9, 2012

The Fed sold half its short-term notes via Operation Twist

The Fed has now sold over half of its short-term treasury note holdings (sold $269bn with $257bn remaining) as part of the Maturity Extension Program (Operation Twist). The bulk of the purchases have been in the 8-10yr and the 20-30yr buckets.


Source: Barclays Capital
Now what happens when the Fed runs out of short-term paper to sell? The program is supposed to end this summer, likely before the Fed actually runs out of short-term notes. It is possible the Fed will extend the program until it simply has no more notes to sell. Here are some possible alternatives after that point.

1. Let the program expire and/or wait until some of the paper in the 3-6yr bucket rolls into the shorter term bucket giving the Fed more "gunpowder".

2. Convert Operation Twist into sterilized asset purchases. That essentially accomplishes the same thing, except rather than swapping 2-year notes into long dated treasuries, the Fed would essentially be swapping short term (possibly overnight) repo loans into long-term treasuries.

3. Move to do more outright purchases (QE3). This outcome is unlikely even in the face of Friday's employment numbers for reasons described here.

Either way, at its current pace of Operation Twist the Fed will run out of short term notes about six months from now (roughly around the one-year anniversary of the program).


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