The Federal Reserve’s Operation Twist in the books. To some extent, the project has been a success. The goal of Operation Twist was to twist the yield curve and drive down long term interest rates. In the days since Operation Twist began, the 10-year Treasury rate has dropped in lockstep with the Fed’s actions.
Operation Twist is just the latest in a variety of Fed actions over the last few years. We have Quantitative Easing (QE) 1 and QE2, a pledge to keep interest rates at current low levels through 2013, and a variety of other economic tinkering. But what can the Fed do now? Does Ben Bernanke have more options to stimulate the economy?
The Market Rejects Operation Twist
In looking to other options, we first have to see if Operation Twist works in boosting economic output. Yes, the Twist was successful in lowering long term interest rates. But did lowering those rates really help the economy? In the short run, the answer is a resounding no. The stock market took a huge nose dive after Operation Twist was announced to the tune of almost a 4% single day decline. However, other important economic news, like the continued sovereign debt issues in Europe, continues to muddy the waters.
A simplistic way to view Operation Twists long term impacts is from a consumer’s point of view. Lowering long term interest rates (like the 10-year Treasury) impact other rates, specifically mortgage rates. The 30-year mortgage follows the 10-year Treasury. So was the rate decline enough to pull American consumers back into the housing market? The seasonally adjusted home sales figures in the 4th quarter will be very telling. In the mean time, however, let’s look at a simple example to make our guess.
Before Operation Twist, a typical 30-year mortgage was running around 4.25%. After the Twist, the rates have moved to about 4.00% (as September 23rd). In 2010 the median home price in America was about $220,000. Let’s assume that on average someone will put down 5% on their home today. This assumption reflects the high amount of FHA loans as well as many conventional loans. The loan amount would settle around $209,000.
The problem is that the payment difference is only about $30 a month. I know every little bit helps, but putting that $11,000 of hard-earned cash back into a housing market that you feel unstable is scary right now. Rates are already super-low; the incremental shifts might not be moving the needle.
Other Policy Options?
So what about other options? The Fed could continue to reduce the Federal Funds Rate, but at 0.25% there is little wiggle room there. Another option would simply be for the Fed to communicate more openly about its view of the economy and the reasoning behind its decisions. For instance, the Fed could telegraph exactly what it would need to see in terms of economic measures before it allows rates to rise. Additionally, there is always the possibility of Quantitative Easing round 3. But given the political firestorm surrounding QE2, I’m betting Bernanke could be scared off that choice.
Organic Growth Needed
For most Fed watchers, the simple answer now is that organic jobs and economic growth is needed. Rates are low, conditions for growth are good, and many companies are positioned well to take advantage of growth. However, the American psyche has been battered so badly in the last downturn, that it may take several quarters of sustained increases in economic output before consumer sentiment returns to anywhere near pre-2008 levels.