Quote of the Day: Bond Girl, Self-Evident

Bond Girl on Operation Twist:

“The duration of the Fed’s portfolio is not what is standing between us and economic prosperity.  Get real, people.”

Quick tutorial: “Operation Twist” is when the Fed extends the maturity of its portfolio, to bring down longer term rates and flatten the yield curve.

Earlier this week, Bill Gross elucidated an “unintended consequence” of Operation Twist:

“The front end of the curve has for all intents and purposes become inert and worst of all flat as opposed to steeply positive.  Two-year yields are the same as overnight fund rates allowing for no incremental gain – a return that leveraged banks and lending institutions have based their income and expense budgets on.  A bank can no longer borrow short and lend two years longer at a profit…

By flooring maturities out to two years then, and perhaps longer as a result of maturity extension policies envisioned in a forthcoming Operation Twist later this month, the Fed may in effect lower the cost of capital, but destroy leverage and credit creation in the process.  The further out the Fed moves the zero bound towards a system-wide average maturity of seven to eight years the more credit destruction occurs, to a US financial system that includes thousands of billions of dollars of repo and short-term financed-based lending that has provided the basis for financial institution prosperity.”

-KD

 

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