Changes over the past few days alone:
The US yield-curve continues its dramatic flattening. All of which is quite in line with the quantitative easing policy - designed to bolster the economy by flooding the banking system with money - that dare not speak its name at the Fed.
As well as - or perhaps better put because of - such easing, Bernanke is twisting.
In 1961, the Fed launched the first - formally, only - “Operation Twist”. The idea then was that the Fed would use its powers in open market operations to target asset prices: specifically, to flatten the yield curve. The Fed operated directly in the long term Treasuries market in an effort to depress long-term borrowing costs (and thus stimulate economic growth) while simultaneously seeking to prop the dollar by supporting shorter term rates.
And here is Bernanke speaking yesterday:
Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve’s quiver–the provision of liquidity–remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand.
The Fed’s actions though, are not yet being felt where they are needed. This graph - and commentary - comes from BNP Paribas today:
Over the past 12 months there has been a strong correlation between the steepness of the US yield curve and the iTraxx Main: the more the US curve steepened, the more credit spreads widened… In the last 4-5 weeks, however, the correlation has broken down.
BNP think the breakdown will persist. We’d agree, but perhaps adding that assuming the Fed sticks to its yield flattening QE policy, the correlation reasserting itself will be a good sign of a recovery. Quite when that happens, particularly given the vicious new default cycle we are about to move into, isn’t really clear.
Related links:
Opening comments December 02 - Across the Curve
TARP lives! - FT Alphaville
Fed capitulates, redux: quantitative easing in the USA - FT Alphaville
