The original program was set to expire at the end of June, but the Fed decided to extend it until the end of the year, likely because they felt that the pace of growth has slowed but hasn’t slowed enough to warrant another full size stimulus injection.
So the Fed will once again try and “twist” the yield curve instead by purchasing longer-term bonds with proceeds from the sale of short-term bonds to the tune of $267 billion.
This latest effort will help to keep longer-term interest rates low and encourage more borrowing to help spur the economy.
In other words, the $400 billion exchange of bonds during the first go around wasn’t enough to bolster any sustainable improvement to our fledgling economy – so what’s another $267 billion, right?
But while round one has kept long-term borrowing costs low since last October, the weak job market and stubbornly high unemployment rate hasn’t exactly translated into more lending by banks.
Some economists reckon that Twist 2.0 will provide marginal stimulus to the economy at best, but is nowhere near as effective as a large-scale asset purchase program like QE3.
That said, Bernanke did comment during the press conference that the Fed is prepared to do what’s necessary in case things get worse – leaving open the possibility of QE3 in the near future.
So with OT in effect until December, what does this mean for investors?
Well, if the ripple effects of previous stimulus measures are any indication, we’ll likely see a short-term rally in the coming months.
During QE1, we saw the S&P 500 Index rise 80% between November 25, 2008 and March 31, 2010.
QE2 saw a 33% gain in the Index between November 3, 2010 and June 30, 2011.
Operation Twist 1.0 resulted in a 29% increase for the Index between October 3, 2011 and June 30, 2012.
With Operation Twist 2.0, I believe there’s a strong likelihood the markets will move up in the weeks ahead.
And if QE3 is finally announced – as I predict it will – we could be in for a very strong second half to 2012.
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