What's The Investment Impact Of Operation Twist?

Includes: CIM, GLD, NLY, SLV
by: Shaun Connell

Operation Twist just got an extension, with another $200+ billion worth of bonds to be purchased and/or sold in an effort to manipulate interest rates even lower.

This means quite a few things, most importantly, that the Fed is essentially running out of bullets. This won't have much of an impact to the economy in the context of the economy slowing -- this alone won't have much of an impact other than trying to apply the breaks to a feared new recession.

Either way, the impact certainly will be there -- but it's not going to be a positive one for the economy overall, but it certainly can be one for those of us who react to the extension accordingly, especially those of us looking into real estate markets right now.

What Operation Twist Does

Operation Twist is when the Fed essentially buys long-term bonds and sells short-term bonds, essentially manipulating interest rates down slightly, or so the goal states.

This operation is one of many reasons interest rates have been falling over the last couple of year or so, and will likely continue the slight fall onward, though when it stops, it could be deadly to short-term economic growth.

It's not the only reason, of course, but is still part of the Fed's overall plan to continue manipulating interest rates lower and lower in a bid to get credit flowing.

The Long-Term Economic Impact

This is the controversial part. The economic impact of interest rate manipulation is economic destruction. This is absolutely unavoidable. Prices exist for a reason. The government shouldn't centrally plan prices anymore than they can centrally plan anything else.

Interest rate manipulation is an effectual price control, because it ignores the supply and demand signals that prices reflect.

Only the difference between interest rate manipulation is that there isn't suddenly a shortage of resources -- but there are malinvestments.

A malinvestment would include plenty of investments that wouldn't exist in a free market for a reason. I can't believe I have to say this, but an obvious example would be the low interest rates and easy credit being dished out to subprime borrowers before the great housing crash.

The economic principles we should have stopped fighting and started embracing in 2008 are apparently being ignored by the Fed right now.

Others are, rightly, worried about inflationary impact of low interest rates. This includes the Richmond Fed Chief who was the lone dissenter to the move of extension of Operation Twist:

I dissented on this decision because I do not believe that further monetary stimulus would make a substantial difference for economic growth and employment without increasing inflation by more than would be desirable. While the outlook for economic growth has clearly weakened in recent weeks, the impediments to stronger growth appear to be beyond the capacity of monetary policy to offset. Inflation is currently close to 2 percent, which the Committee has identified as its inflation goal. A significant increase in inflation could threaten the Fed's credibility and make it more difficult to achieve the Committee's longer-run goals, including maximum employment. Should a substantial and persistent fall in inflation emerge, monetary stimulus may be appropriate to ensure the return of inflation toward the Committee's 2 percent goal.

I'm not so sure his point about inflation makes much sense (inflation has plummeted in the last month or so), but he's right about OT being essentially a mute point. If anything, the renewal just looks more like a hint at being willing to do more if the economy continues to slow.

The Short-Term Investment Impact

Companies that rely on low interest rates like the current low mortgage rates will likely get a shot in the arm, or at least won't suddenly get destroyed by rising rates as much as they would alternatively.

The impact of low interest rates is likely to be relatively little impact for gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) prices without QE3, and the overall stock market will most likely see little impact as well. If there's fear of deflation, gold prices will likely stay flat or fall.

The only investments that will be getting a gentle push from this would likely be interest-rate heavily dependent investments like real estate and all-things REIT over the next several months -- assuming the Fed completely achieves its goal of keeping short-term interest rates the same and pushing long-term interest rates down.

A house is still a great investment, and even more so now than a few months ago when I wrote that article originally. REIT and mREITs like Annaly were supposedly under negative pressure from Operation Twist, though the impact seemed negligible at best. Still, long-term interest rates falling makes it more difficult for Annaly to pull more profits in, because they make their money with mortgage-backed securities -- so lower long-term interest rates with stable short-term interest rates make it more difficult for them to make money with those long-term mortgage securities.

Still, the impact on companies like Annaly (NYSE:NLY), Chimera (NYSE:CIM) and similar companies won't likely be enough to make them not good bets for the next year. Unless we see a sudden recovery with inflation (I wouldn't bet on it), these companies are likely in great shape for some volatile-but-high-yield returns.

Personally, I'm looking forward to cashing in on the renewal of Operation Twist and the cheap interest rates, and have sold off some of my portfolio to purchase an actual house, something I haven't done before. Over the next few months, I'll make sure to write more about real estate, interest rates, and how much the Fed's impact will be felt -- if much at all.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I own physical gold and silver and will be buying more in the near future. I will also be buying residential property in the near future.