How Will the ‘Twist’ Hit T-Bills?

10/17/2011 8:30 am EST

Focus: BONDS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

US government bonds have been the best place to be lately, and in the medium term Operation Twist should only drive prices higher, observe Mary Anne and Pamela Aden of The Aden Forecast.

Once again, interest rates plunged even further and bond prices soared, rising the most since the 2008 financial crisis.

The ten-year yield dropped below 2% for a while, hitting another record low. And just since our last issue, the 30-year rate fell from 3.24% to 2.71%. [This week’s rally has pushed the ten-year back to 2.2% and the 30-year to 3.15%—Editor.]

Despite these steep declines, interest rates will likely fall to still lower levels.

The Fed essentially triggered all the commotion this month, and we’re fairly sure they’re not done yet. But worries about the slowing global economy, high unemployment, the future of the Eurozone, risk aversion, and ongoing demand for a safe haven all added fuel to the bond bull market’s rise.

In the Fed’s case, its latest plan, Operation Twist, was a big hit—at least it was for the bond market. Whether it’ll help boost the economy, as the Fed hopes, is still to be seen.

Nevertheless, as we’ve seen dozens of times this year, the markets have been reacting to the latest daily news, which may or may not be valid. And bonds have been no exception.

The bottom line is, US government bonds have been the best investment over the past three months. Bonds have strongly outperformed stocks around the world.

Bonds have also been stronger than all of the currencies, and even gold. The percentage gains have been greater and bonds have been the best overall investment. This could continue for a while longer, especially as the Twist gets underway.

In a nutshell, it’s the latest effort by the Fed to kickstart the debt-burdened economy…an economy still plagued by massive unemployment and very weak housing, despite an over two-year recovery and two rounds of quantitative easing to the tune of $2.3 trillion, which were supposed to do the trick. But they didn’t.

Unfortunately, the debt load is weighing heavily on the economy, along with global deflationary pressures. This environment is good for bonds, which is one reason why they’re rising. But the likelihood of another recession is making investors nervous and uncertain, and that too has been a boost for bonds as the flight to safety intensifies.

The Fed hasn’t helped..They’ve acknowledged the US economy is facing significant downside risks. And Bernanke himself said long-term unemployment is a national crisis, which has not happened since World War II. So Operation Twist is their latest way of doing their part to help fix the situation.

This basically means the Fed is going to readjust $400 billion of the US bonds and notes it’s holding by selling short-term notes and buying long-term bonds. It will continue this plan going into the first half of 2012, which will keep downward pressure on long-term interest rates, therefore boosting bond prices.

We’ve often pointed out that the bond market is huge…and it’s a free market. It can’t be manipulated like short-term interest rates can. But this provides an example of the Fed’s influence.

We know the Fed wants to keep interest rates low for a long time to help the economy. They’ve said so. And now, Operation Twist is helping push long-term rates down too.

The world economy, however, is still calling the shots. And since it’s showing signs of slowing, it also adds to the appeal for US bonds.

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