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November 2020 Economic Dashboard

As the stock market climbs to new all-time highs, a little noticed trend has emerged in the longer maturities of the Treasury market.  Interest rates for the 10-year Treasury bottomed at 0.50% on August 6 and climbed to 0.98% on November 9 with the announcement of the first COVID-19 vaccine trial results.  10-year yields are currently 0.85%.  We know, it sounds silly to make hay about an increase of only 0.40% in yields but rising interest rates can be viewed as a tightening in market liquidity, which the Federal Reserve worries will eventually present challenges to the still-fragile economic recovery.

The 2008-2009 Financial Crisis prompted the Fed to use a myriad of tools few market observers knew existed.  The crisis abated after 2010 or so but the Fed remained very worried longer-term interest rates like the 10-year Treasury would increase in yield and slow down the economic recovery.  Fed Chair Ben Bernanke then employed a strategy first used by the Kennedy-era Fed.  “Operation Twist” involved the Fed selling short-term Treasuries and using the proceeds to buy longer-term Treasury notes and bonds. When the Fed acts as the ultimate buyer in the 10-year Treasury market, the increased demand for the bonds means that the Treasury is able sell the bonds at lower yields.  “Operation Twist” thereby is twisting the yield difference in the favor of longer-term borrowers.

While the move does not mean the Fed will pump additional money into the economy, it is designed to lower yields on long-term bonds, while keeping short-term rates little changed.

The intent is to thereby push down interest rates on everything from mortgages to business loans, giving consumers and companies an additional incentive to borrow and spend money.  The 10-year Treasury charts below highlight the change in yields because of the 2011-2012 Operation Twist and the past six months yield activity.

The 2011-2012 Operation Twist ultimately reduced the yield on the 10-year note by 0.75%, a meaningful reduction for any borrower.  We won’t speculate if a 2020-2021 Operation Twist will be as impactful given the low starting yield, though a reduction back to the 0.50% would be significant.

– George S. Farra, CFA

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