What are Open Market Operations?

[Toddsterpatriot]

Many investors do not realize the price risk in long-dated Treasury and other bonds because bonds have been in a secular bull market for so long. The real risk is if interest rates rise 150 basis points, 200 basis points, or even more. Most long-term Treasury investors are not really prepared for that sort of move. Most would even feel like they had been duped by the Fed and the government if the value of their long-term bond portfolio is suddenly worth 10%, 20%, or even 30% less than what they paid.

Uh huh....

Spot on! The value of EXISTING long-term bonds is inversely related to the changes in the CURRENT level of interest rates. If long-term rates on the spot bond market rise, regardless of reason, the value of bond portfolios declines. People who forget that are going to get burned, and then they will cry that the Fed is "devaluing" their bonds.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates ( God knows they have enough in inventory!).

You've made an important point, thanks.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates

Ummmmmm....Fed sales would exacerbate the rise in rates.

 

[oldfart]

So we have no clear cut example of how to short of war end a liquidity trap, and no real guidance on how to handle the transition phase when excess reserves begin to diminish and increases in demand to result in more inflationary pressure. Do we see a replay of 1937 America and fall back into depression? Do we overshoot and end up with the need for another anti-inflation Volker recession? Is there a way to thread the needle and avoid both dangers? Find a convincing answer, and you have my nomination for for the Sveriges Riksbank Prize!

Looks to me that there is an opportunity to utilize some careful stimulus that could have a good result relative to employment increases, and good results on the economy over time. In that vein, perhaps proper infrastructure improvement aimed at both employment AND long term help with the economy. New energy areas, perhaps. And in general improvement in transportation for both business and safety reasons. And, I am of the strong opinion that we need to do something in the area of education, particularly aimed at providing the work skills and business development skills that we will need assuming we do not want to flip burgers and change money off into the future.
I have seen way too much of the need in our country to import talent from other countries to fill the high skilled positions of our economy. Seems to me we need to get serious about educating our own folks to fill as many of those positions as possible in a competitive way.

Not all stimulus is created equal. Not only are some methods more effective in promoting jobs and growth, some stimulus can increase a nation's capital stock and promote higher long term growth. We will pay a hundred times over for the piddling reductions in NIH supported research that "saves" less than $10 billion in the sequester, when 18% of our researchers are considering moving overseas. We pay somewhere in the neighborhood of one or two million a pop to educate a PhD level researcher in the sciences, and after they are trained and productive, we ship them overseas?

 

[oldfart]

Many investors do not realize the price risk in long-dated Treasury and other bonds because bonds have been in a secular bull market for so long. The real risk is if interest rates rise 150 basis points, 200 basis points, or even more. Most long-term Treasury investors are not really prepared for that sort of move. Most would even feel like they had been duped by the Fed and the government if the value of their long-term bond portfolio is suddenly worth 10%, 20%, or even 30% less than what they paid.

Uh huh....

Spot on! The value of EXISTING long-term bonds is inversely related to the changes in the CURRENT level of interest rates. If long-term rates on the spot bond market rise, regardless of reason, the value of bond portfolios declines. People who forget that are going to get burned, and then they will cry that the Fed is "devaluing" their bonds.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates ( God knows they have enough in inventory!).

You've made an important point, thanks.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates

Ummmmmm....Fed sales would exacerbate the rise in rates.

Brain fart. You're right I have it reversed. It'll happen to you too when eating oatmeal sounds exciting!

 

[Rshermr]

Spot on! The value of EXISTING long-term bonds is inversely related to the changes in the CURRENT level of interest rates. If long-term rates on the spot bond market rise, regardless of reason, the value of bond portfolios declines. People who forget that are going to get burned, and then they will cry that the Fed is "devaluing" their bonds.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates ( God knows they have enough in inventory!).

You've made an important point, thanks.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates

Ummmmmm....Fed sales would exacerbate the rise in rates.

Brain fart. You're right I have it reversed. It'll happen to you too when eating oatmeal sounds exciting!

what else ya going to do on a friday night??

 

[Kimura]

By the way, if we look at what's transpired, QE hasn't decreased rates towards the long end of the yield curve. Mortgage rates have increased and housing has seen no tangible benefits in my estimation.

Since you seem to like the deep water, here goes!

QE is pretty straightforward in that monetary policy only generally affects the short end of the yield curve, i.e. the yield on short-term Treasuries (under 3 years). In 1961 and again in 2011 the Fed tried "Operation Twist" (yes, named after Chubby Checker's hit song and dance craze). The Fed bought long term Treasuries to force the price up and the yield down, using sales of short-term Treasuries acquired in the course of QE to avoid printing money. Re-evaluation of the 1961 episode lead to a conclusion that Twist had been more effective than thought at that time and that another attempt might be worthwhile.

The problem was that the amount of short-term Treasuries on the Fed balance sheet was inadequate to carry out the level of operations thought needed. So the QE/Operation Twist experiment did not meet expectations. Since there was really no downside, I'd call it a success.

Currently the Fed says that it's long term inflation goal is 2%. If credible, I think this puts a floor on the long-term Treasury rates. I think we are in the situation of states that have legalized casino gambling and a lottery. Both generate revenue, but not as much as you would expect by adding projections together. Both are tapping the same pool of money. Similarly, the more tools we deploy (at least monetary tools) to lower interest rates as a stimulus measure, the less effective the combination will be. These things are simply not additive.

IMHO the best policy is to restrict Operations Twist to availability of short-term Treasuries in the Fed portfolio. We are stuck with the yield curve that does not flatten sufficiently, but I do not see a policy that would make this better without dire side effects. The announced inflation goal is a better tool. The Treasury--TIPS spread has gone from 1.5% to 2.2% over the last half year or so. I have no statistical evidence, but my gut tells me that the markets are becoming convinced that the Fed is serious about the long-term inflation target and that is at least contributing to the rise in market inflation expectations.

Now if we could only figure out how to take those mortgage-backed agency securities the Fed has been buying up in QE and dismantle the tranches so the underlying mortgages can be resolved........

I love the deep waters!

I'd also like to add that QE - and FED actions in general - have removed a tremendous amount of money from the economy. A massive amount. In point of fact, the FED has removed over roughly $100 billion more income then total aggregate net increases in salaries/wages since it began these QE and other assorted asset operations.

The FED removes an asset - a US Treasury - and swaps it out with cash (reserves) in the banking system. The end result is that the private sector is deprived of interest it could have made on US Treasuries, which is more than the zero percent it would earn as a cash balances so to speak.

For example, last year the FED made a total profit of 88.9 billion dollars, which it turned back over to the Treasury. This profit was a direct result of the assets it purchased. This is income which could have been earned by the private sector if it had owned those bonds and securities.

It continues to drive me up a wall when economists refer QE as a "stimulus". Nothing could be further from the truth.

 

[Toddsterpatriot]

By the way, if we look at what's transpired, QE hasn't decreased rates towards the long end of the yield curve. Mortgage rates have increased and housing has seen no tangible benefits in my estimation.

Since you seem to like the deep water, here goes!

QE is pretty straightforward in that monetary policy only generally affects the short end of the yield curve, i.e. the yield on short-term Treasuries (under 3 years). In 1961 and again in 2011 the Fed tried "Operation Twist" (yes, named after Chubby Checker's hit song and dance craze). The Fed bought long term Treasuries to force the price up and the yield down, using sales of short-term Treasuries acquired in the course of QE to avoid printing money. Re-evaluation of the 1961 episode lead to a conclusion that Twist had been more effective than thought at that time and that another attempt might be worthwhile.

The problem was that the amount of short-term Treasuries on the Fed balance sheet was inadequate to carry out the level of operations thought needed. So the QE/Operation Twist experiment did not meet expectations. Since there was really no downside, I'd call it a success.

Currently the Fed says that it's long term inflation goal is 2%. If credible, I think this puts a floor on the long-term Treasury rates. I think we are in the situation of states that have legalized casino gambling and a lottery. Both generate revenue, but not as much as you would expect by adding projections together. Both are tapping the same pool of money. Similarly, the more tools we deploy (at least monetary tools) to lower interest rates as a stimulus measure, the less effective the combination will be. These things are simply not additive.

IMHO the best policy is to restrict Operations Twist to availability of short-term Treasuries in the Fed portfolio. We are stuck with the yield curve that does not flatten sufficiently, but I do not see a policy that would make this better without dire side effects. The announced inflation goal is a better tool. The Treasury--TIPS spread has gone from 1.5% to 2.2% over the last half year or so. I have no statistical evidence, but my gut tells me that the markets are becoming convinced that the Fed is serious about the long-term inflation target and that is at least contributing to the rise in market inflation expectations.

Now if we could only figure out how to take those mortgage-backed agency securities the Fed has been buying up in QE and dismantle the tranches so the underlying mortgages can be resolved........

I love the deep waters!

I'd also like to add that QE - and FED actions in general - have removed a tremendous amount of money from the economy. A massive amount. In point of fact, the FED has removed over roughly $100 billion more income then total aggregate net increases in salaries/wages since it began these QE and other assorted asset operations.

The FED removes an asset - a US Treasury - and swaps it out with cash (reserves) in the banking system. The end result is that the private sector is deprived of interest it could have made on US Treasuries, which is more than the zero percent it would earn as a cash balances so to speak.

For example, last year the FED made a total profit of 88.9 billion dollars, which it turned back over to the Treasury. This profit was a direct result of the assets it purchased. This is income which could have been earned by the private sector if it had owned those bonds and securities.

It continues to drive me up a wall when economists refer QE as a "stimulus". Nothing could be further from the truth.

The end result is that the private sector is deprived of interest it could have made on US Treasuries,

But...but...but...isn't the Fed giving free money to the banks and buying their crap bonds?

It's funny when you see the misinformation most people swallow when it comes to the banking system and the Fed.

 

[Kimura]

Since you seem to like the deep water, here goes!

QE is pretty straightforward in that monetary policy only generally affects the short end of the yield curve, i.e. the yield on short-term Treasuries (under 3 years). In 1961 and again in 2011 the Fed tried "Operation Twist" (yes, named after Chubby Checker's hit song and dance craze). The Fed bought long term Treasuries to force the price up and the yield down, using sales of short-term Treasuries acquired in the course of QE to avoid printing money. Re-evaluation of the 1961 episode lead to a conclusion that Twist had been more effective than thought at that time and that another attempt might be worthwhile.

The problem was that the amount of short-term Treasuries on the Fed balance sheet was inadequate to carry out the level of operations thought needed. So the QE/Operation Twist experiment did not meet expectations. Since there was really no downside, I'd call it a success.

Currently the Fed says that it's long term inflation goal is 2%. If credible, I think this puts a floor on the long-term Treasury rates. I think we are in the situation of states that have legalized casino gambling and a lottery. Both generate revenue, but not as much as you would expect by adding projections together. Both are tapping the same pool of money. Similarly, the more tools we deploy (at least monetary tools) to lower interest rates as a stimulus measure, the less effective the combination will be. These things are simply not additive.

IMHO the best policy is to restrict Operations Twist to availability of short-term Treasuries in the Fed portfolio. We are stuck with the yield curve that does not flatten sufficiently, but I do not see a policy that would make this better without dire side effects. The announced inflation goal is a better tool. The Treasury--TIPS spread has gone from 1.5% to 2.2% over the last half year or so. I have no statistical evidence, but my gut tells me that the markets are becoming convinced that the Fed is serious about the long-term inflation target and that is at least contributing to the rise in market inflation expectations.

Now if we could only figure out how to take those mortgage-backed agency securities the Fed has been buying up in QE and dismantle the tranches so the underlying mortgages can be resolved........

I love the deep waters!

I'd also like to add that QE - and FED actions in general - have removed a tremendous amount of money from the economy. A massive amount. In point of fact, the FED has removed over roughly $100 billion more income then total aggregate net increases in salaries/wages since it began these QE and other assorted asset operations.

The FED removes an asset - a US Treasury - and swaps it out with cash (reserves) in the banking system. The end result is that the private sector is deprived of interest it could have made on US Treasuries, which is more than the zero percent it would earn as a cash balances so to speak.

For example, last year the FED made a total profit of 88.9 billion dollars, which it turned back over to the Treasury. This profit was a direct result of the assets it purchased. This is income which could have been earned by the private sector if it had owned those bonds and securities.

It continues to drive me up a wall when economists refer QE as a "stimulus". Nothing could be further from the truth.

The end result is that the private sector is deprived of interest it could have made on US Treasuries,

But...but...but...isn't the Fed giving free money to the banks and buying their crap bonds?

It's funny when you see the misinformation most people swallow when it comes to the banking system and the Fed.

It's a comedy show, we should take it on the road.