Operation Twist has investors moving
https://www.ft.com/cms/s/0/ba15
September 25, 2011 7:45 pm
Operation Twist has investors moving
By Michael Mackenzie and Dan McCrum in New York
Investors are responding to the Federal Reserve’s new easing policy by unwinding trades that benefited from a weak dollar and the prospect of higher inflation.
Traders are selling oil, gold, inflation-linked bonds, equities and emerging market securities as the Fed has moved away from previous policies that fanned worries that the strength of the US currency was being reduced.
The central bank’s introduction of Operation Twist marks a departure from its two rounds of quantitative easing, which saw the Fed buying bonds. Now the central bank is selling shorter-term Treasury holdings, and buying long-term debt and mortgage-backed securities, as part of an effort to dramatically lower market interest rates.
The move is seen by analysts and traders as a renewed attempt to help homeowners via lower mortgage rates, and a break with policies that pumped up global financial asset prices via a weaker dollar.
Alan Ruskin, strategist at Deutsche Bank, said: “The market has delivered its initial verdict – without an expansion of the Fed’s balance sheet the US dollar is a natural beneficiary.”
Prya Misra, rates strategist at Bank of America Merrill Lynch, said: “The Fed is signalling it is ready to act to support mortgage refinancing activity.”
Since the Fed ended QE2 in June, many asset prices have endured a bumpy ride, with the dollar benefiting from safe haven flows.
Selling pressure sharply intensified last week when details of Operation Twist emerged and policymakers warned of “significant downside risks to the economic outlook, including strains in global financial markets”.
Since the Fed concluded its meeting, gold alone has tumbled 8 per cent to $1,656 an ounce, while US oil prices dropped from $86 to below $80 a barrel, their lowest level in more than a year.
The sell-off in global equities accelerated last week, pushing the FTSE All World index into bear market territory, with a drop of more than 20 per cent from its high in May.
In contrast, the dollar reached its highest level in seven months with a jump of 1.9 per cent on a trade-weighted basis in the wake of Operation Twist.
“The QE2 trade of selling the dollar and buying commodities is in reverse and will continue,” said Richard Gilhooly, strategist at TD Securities.
Mr Gilhooly said the Fed has reversed course from QE2 and is now trying to lower long-term rates and support the housing market, rather than weaken the dollar via expanding its balance sheet and pumping up inflation expectations.
The reversal in risky assets is also occurring at a time of thinning liquidity and poor trading conditions, raising the prospect of further volatility, particularly with this week marking the end of the third quarter, when banks and investors reduce activity towards the close of the financial reporting period.
Mark Kiesel, portfolio manager at Pimco, commented: “Markets are very illiquid, and risk-taking is falling as we approach the end of the quarter.
“It is not as bad as we saw in late 2008 and early 2009, but liquidity is extremely low.”
The lack of liquidity makes it hard for investors to significantly adjust positions in response to the market moves.
Stephen Walsh, chief investment officer for Western Asset Management, explained: “In terms of the Westerns, the Pimcos, the larger firms, the ability to freely trade and move positions is as challenging as it’s been really since the crisis, and I have talked to virtually every one of our counterparties and they agree.”
While equities and other risk assets may look attractive after large price declines, worries over the eurozone debt crisis and global economic growth hang over bargain hunters.
Mr Kiesel said: “Investors should wait to see whether policymakers can be effective in formulating a co-ordinated and credible solution for Europe before taking on more risk.”