What is an 'Operation Twist'

Operation Twist is the name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds. The operation describes a monetary process where the Fed buys and sells short-term and long-term bonds depending on their objective.

Operation Twist is a form of monetary easing, but unlike quantitative easing, it does not expand the Fed's balance sheet, making it a less aggressive form of easing.

BREAKING DOWN 'Operation Twist'

The name "Operation Twist" was given by the mainstream media due to the visual effect that the monetary policy action was expected to have on the shape of the yield curve. If you visualize a linear upward sloping yield curve, this monetary action effectively "twists" the ends of the yield curve, hence, the name Operation Twist. To put another way, the yield curve twists when short-term yields go up and long-term interest rates drop at the same time.

Operation Twist first came about in 1961 when the Federal Open Market Committee (FOMC) sought to strengthen the US dollar and stimulate inflows of cash into the economy. At this time, the country was still recovering from a recession following the end of the Korean war. In order to promote spending in the economy, the yield curve was flattened by selling short-term debt in the markets and using the proceeds from the sale to purchase long-term government debt. Remember there is an inverse relationship between bond prices and yield – when prices go down in value, the yield increases, and vice versa. The Fed’s purchasing activity of long-term debt drives up the price of the securities and, in turn, decreases the yield. When long-term yields fall faster than short-term rates in the market, the yield curve flattens to reflect the smaller spread between the long-term and short-term rates.

Also note that selling short-term bonds would decrease the price and, hence, increase the rates. However, the short end of the yield curve based on short-term interest rates is determined by expectations of the Federal Reserve policy, rising when the Fed is expected to raise rates and falling when interest rates are expected to be cut. Since Operation Twist involves the Fed leaving short-term rates unchanged, only the long-term rates will be impacted by the buy and sell activity conducted in the markets. This would cause long-term yield to decrease at a higher rate than short-term yield.

In 2011, the Fed could not reduce short-term rates any further since the rates were already at zero. The alternative then was to lower long-term interest rates. To achieve this, the Fed sold short-term Treasury securities and bought long-term Treasuries, which pressured the long-term bond yields downward, thereby, boosting the economy. As short-term Treasury bills and notes matured, the Fed would use the proceeds to buy longer-term Treasury notes and bonds. The effect on short-term interest rates was minimal as the Fed had committed to keeping short-term interest rates near zero for the next couple of years. During this time, the yield on 2-year bonds was close to zero and the yield on 10-year Treasury bonds, the benchmark bond for interest rates on all fixed-rate loans, was only about 1.95%.

A fall in interest rates reduces the cost of borrowing for businesses and individuals. When these entities have access to loans at low interest rates, spending in the economy increases and unemployment falls as businesses can affordably secure capital to expand and finance their projects.

RELATED TERMS
  1. Yield Curve Risk

    The yield curve risk is the risk of experiencing an adverse shift ...
  2. Normal Yield Curve

    The normal yield curve is a yield curve in which short-term debt ...
  3. Inverted Yield Curve

    An inverted yield curve is the interest rate environment in which ...
  4. Yield Curve

    A yield curve is a line that plots the interest rates, at a set ...
  5. Intermediate/Medium-Term Debt

    Medium-term debt is a type of fixed income security with a maturity, ...
  6. Yield Spread

    A yield spread is the difference between yields on differing ...
Related Articles
  1. Investing

    Understanding Treasury Yield And Interest Rates

    By understanding the factors that influence treasury yield and interest rates, you can learn to anticipate their movement and profit from it.
  2. Investing

    One Thing The Yield Curve Says About Stocks

    Contrary to media hype, a flattening yield curve does not mean a recession is coming soon.
  3. Investing

    How Bond Market Pricing Works

    Want to know how bond price are determined? Learn the basic rule of the bond market.
  4. Investing

    3 Best Bond Strategies in a Rising-Rate Environment

    Find out which bond strategies offer the best protection and investment return during the Federal Reserve's monetary tightening cycle.
  5. Insights

    U.S. Recession Without a Yield Curve Warning?

    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
  6. Investing

    3 Risks U.S. Bonds Face in 2016

    Learn about the major risks for the bond market in 2016; interest rate increases, high-yield bond volatility and a flatter yield curve may be issues.
  7. Investing

    The Importance Of U.S. Treasury Rates

    U.S. Treasury bond interest rates affect more than just bondholders! It impacts the day to day lives of all consumers.
  8. Investing

    Understanding Treasury Yield

    Treasury yield refers to the return on an investment in a U.S. government debt obligation, such as a bill, note or bond.
  9. Investing

    Understanding the Different Types of Bond Yields

    Any investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
  10. Insights

    Why the 10-Year U.S. Treasury Yield Matters

    10-year treasury bond yields are important indicators of the economy as a whole.
RELATED FAQS
  1. What is the current yield curve and why is it important?

    Understand what the current yield curve represents, and learn how market analysts commonly interpret various changes in the ... Read Answer >>
  2. What does market segmentation theory assume about interest rates?

    Learn how the market segmentation theory for different maturities of interest rates seeks to describe the shape of the yield ... Read Answer >>
  3. How are bond yields affected by monetary policy?

    Learn about how bond yields are affected by monetary policy. Find out how this determines the risk-free rate of return and ... Read Answer >>
  4. How can bond yields influence the stock market?

    Learn how bond yields influence the stock market. The relationship between bond yields and stocks changes depending on the ... Read Answer >>
Trading Center