Economic Stimulus From the FED – Twist 2.0

As inflation was tame, stocks prices went lower, and unemployment higher, many investors thought that another round of Quantitative Easing would be on the top of Fed chairman Ben Bernanke’s to-do list. Instead the FED once again reintroduced Operation Twist where a swapping of short- and long-term bonds, would lower the longer term bond yields until the end of 2012.

Operation Twist 2.0 is a suppression of interest rate scheme and does not really help the stock market, as it does not directly create inflation. It will not be long until the markets get over this ‘mediocre’ news and much more stimulus will probably be needed to help push up stock and asset prices. However, since this is an election year in the US, the government is likely to delay any stimulus programs until after the elections. Nevertheless, if the European markets continue to be sluggish, expect more intervention from the European Central Bank (ECB) and national banks from any other country, rather than from the Fed. – Exactly what happened this week, as Europe moves to launch their own European TARP program.

However, In the event of another major bank failure in the US, the Fed could very well trigger the stimulus gun as there are several more opportunities that the Federal Open Market Committee (FOMC) meet this year (July 31-August 1; September 12-13; October 11-12; and December 11-12).

If your remember, the Fed’s response to the credit crisis in 07-08, resulted in lower interest rates to jump-start the economy. The irony of which is that suppressed interest rates by the Fed helped spawn increasingly more malinvestments.  Of course, it could be said that this strategy “saved” the economy from a depression, and this is technically true if considering a short-term economic plan. It is when interest rates do rise, as we have seen in much of Europe, that the Fed must continue to purchase an ever increasing number of its own bonds to prevent rate hikes. The alternative would be to let interest rates rise to react with the free-market forces, at which point many malinvestments would have to be liquidated into the markets.

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