The Fed's twist in the words of JP Morgan

JP Morgan expects that US Federal Reserve will announce that it is to auction between $300bn and $400bn in Treasuries with one to three years to reach maturity, and that it will concentrate 70% of its purchases on seven to 12 year-maturity securities while the other 30% will be on longer maturities. The bank believes that the Fed will carry out these acquisitions within the next 6 months.

“The benefit from Operation Twist is the same as from QE (quantitative easing) — removing duration from the market should exert downward pressure on longer-term interest rates. Operation Twist has the added benefit of doing so without increasing reserves in the banking system, thereby avoiding the monetization and hyperinflation blather that accompanied quantitative easing.

“The downside is that it can complicate the exit strategy as it slows down the natural rhythm of contraction of the balance because of the longer-term maturities.

On the other hand, JP Morgan points out, there is the possibility that the Fed decided to lower the interest on excess reserves from the present 25bp to 12.5bp or even 10bp:

“We consider that there is a 50% chance of this happening. There may even be talk about guidance of rates. One must remember the proposal made by the Chicago Federal Reserve Chairman, who suggested that rates remain at zero until the unemployment rate falls below 7.5%. Of course, this is only valid if inflation is not triggered. It is more probable, though, that this is subject to be kept as ammunition in case the data slows down in the coming months.”

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