Markets Unsatisfied With Second Twist

On Wednesday, the Federal Open Market Committee released its decision on interest rates. The FOMC opted to leave rates unchanged, as nearly all analysts had anticipated. Rather, the key news from the meeting was that the FOMC had decided to conduct a second "Operation Twist." Under the plan, the FOMC will purchase longer duration securities while selling treasuries with shorter durations. Overall, the Fed will shift $400 billion of its balance sheet from the short end to the long. However, unlike other recent Fed interventions, the FOMC will not increase the size of its balance sheet. Since the financial crisis of 2008, the Fed has conducted two rounds of quantitative easing. Popularly referred to as QE1 and QE2, the FOMC increased the agency's balance sheet by buying securities in the open market. Why did the Fed opt to twist rather than ease? Pressure has been mounting on the Fed in recent months. Although the Fed denies involvement, many economic commentators have cited QE2 as the primary catalyst behind the recent run-up in commodity prices. Higher commodity prices may have been tolerable if the Fed had managed to drive down unemployment. However, unemployment has remained persistently above 9%. It is difficult enough for an employed person to cope with rising prices at the grocery store and the gas pump, let alone those without steady incomes. On Tuesday night, members of the Republican Party sent Fed Chairman Bernanke a note, raising questions over the prospect of engaging in further easing. Meanwhile, popular Republican presidential hopeful Rick Perry had openly threatened Bernanke while stumping on the campaign trail. This level of popular opposition to the actions of the Fed has not been seen in recent history. Operation Twist may provide a way for the Fed to lend support to the economy while limiting the growth of the money supply. Yet, market participants appeared relatively unsatisfied with the move. The Dow Jones Industrial Average moved down almost 2%, while the NASDAQ Composite traded down well over 1%. In recent days, rumors had swirled that the Fed may have been considering slashing interest paid on idle reserves to 0% as a way to stimulate the economy. Perhaps markets were anticipating a more aggressive policy along those lines. Perhaps this will be the Fed's last aggressive action, but it may not yet be finished. If unemployment remains persistently high, the Fed may have to continue to act going forward.