Wednesday, 6 June 2012

Fed Intervention and the Market: New Update

We have a little over three weeks left for the latest Federal Reserve intervention, Operation Twist, which was officially announced on September 21 of last year. We've seen several bouts of aggressive Fed attempts to manage the economy following the collapse of the two Bear Stearns hedge funds in mid-2007 about three months before the all-time high in the S&P 500.

Initially the Fed Funds Rate (FFR) underwent a series of cuts, and with the collapse of Bear Stearns, the Fed launched a veritable alphabet soup of tactical strategies intended to stave off economic disaster: PDCF, TALF, TARP, etc. But shortly after the Lehman bankruptcy filing, the Fed really swung into high gear. The FFR fell off a cliff and soon bounced in the lower half of the 0 to 0.25% ZIRP (Zero Interest Rate Policy), now in its fourth year.
If a picture is worth a thousand words, this chart needs little additional explanation — except perhaps for those who are puzzled by the Jackson Hole callout. The reference is to Chairman Bernanke's speech at the Fed's 2010 annual symposium in Jackson Hole, Wyoming. Bernanke strongly hinted about the forthcoming Federal Reserve intervention that was subsequently initiated in November of 2010, namely, the second round of quantitative easing, aka QE2.


The latest major strategy, Operation Twist, will run through June 2012. The Fed is selling $400 billion of shorter-term Treasury securities and using the proceeds to buy longer-term Treasury securities in an effort to lower interest rates.
With three-plus weeks of "twisting" left, it's still just a bit too soon to make a definitive pronouncement on the success of this strategy for lowering interest rates. Changes can be sudden in this global atmosphere of economic unrest, and the decline in markets around the world is a bit nervous-making. But at this point, the Fed definitely seems to be achieving its "Twist" goal (although they would certainly be happier if the equity markets were not showing signs of a correction). According to the Freddie Mac survey, the 30-year mortgage rate has fluctuated between 4.22% and 3.83% since the first week in September, but the most recent average is the all-time low of 3.75%. Here is a snapshot of selected Treasury yields and the 30-year fixed mortgage (excluding points).
The past three years have been an exciting time for many professional traders and their seasoned amateur counterparts. And it's been a dream-come-true for institutional HFT (high frequency trading) with computerized algorithms. Of course, there have been perils, even for seasoned pros. Thebankruptcy of MF Global is a grim reminder. And now we have the travesty of JPMorgan's trading strategy as a follow-up.
On the other hand, savers — those benighted souls looking for income from CDs, Treasury yields, and FDIC insured money markets — have had a rude introduction to the new reality, one that will apparently be with us for a very long time.

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