Only two groups of investors stand to win from the Operation Twist program announced by the Federal Reserve on Wednesday.
The first group includes investors in long-term Treasuries. One must be glad to have USD 400 bn worth of guaranteed bids! I believe Beijing is more than satisfied. It is somewhat strange though, that one of the People’s Bank of China high-profile officials said the other day that it would be appropriate to “eliminate” investments in US Treasuries and buy stocks of leading US companies… Be that as it may, it may just as well be a mere coincidence.
The second group is represented by a single participant – the US Treasury, as the Fed’s decision all but guarantees it smooth placement of long-term Treasuries at low interest rates.
It is completely unclear, though, what good this program could do to the US economy. Of course, in theory, low interest rates on sovereign debt should help drive down lending rates, including mortgages, which should, in turn, boost lending in the economy and spur consumer demand, corporate profits, employment etc.
The problem is, however, that it is not high lending rates (rates are, in fact, already at historic lows) that are plaguing the US economy. What is undermining the US economy is excessive leverage and “bad” assets which, as experience has shown, cannot be cured by low rates. For an example look at Japan. It’s been 20 years since Japan’s Great Depression officially ended, yet in all those years the country failed to achieve a steady economic growth and its sovereign debt has reached 200% of GDP. Unfortunately, there are economics scholars out there who go by the maxim: “If practice contradicts theory, so much the worse for it”.
Replacement of shorter-dated bonds with longer-dated bonds in the Fed’s bond portfolio will mean more short-term bonds will be concentrated in the aggregate investor portfolio which is tantamount to setting a time bomb for US sovereign debt interest rates. As soon as the market notices that the US economy is rapidly sliding into stagflation (GDP growth was under 1% in the first six months of this year, while CPI came in at 3.8% over the past twelve months) and realizes that the Federal Reserve has run out of efficient monetary ammunition and is unable to put the economy on firm footing, nothing will be able to stop the flight of capital from Treasuries. Precious metals and shares will, in my view, benefit most, as history shows that in times of rising inflation investments in gold and stocks return higher profits than investments in bonds.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long non US gold ETF.