Bill Gross Warns QE3 Is Coming In The Form Of "Operation Twist" For The 2 Year

Tyler Durden's picture

Bill Gross released a very troubling tweet earlier:

Why is it odd? Because as David Rosenberg predicted two weeks ago when he expected that Operation Twist could be coming back with the Fed "capping" the 10 Year, Bill Gross, who has Larry "Fed Expert Network" Meyer in his ear and thus knows better than most what is coming, is predicting some "Twisting" though not at the 10 Year mark, but at the very short end. This is very disturbing. Because as we suggested at the end of May, QE3 will in reality be Operation Twist 2...

This means that Rosie's prediction that "the Fed would basically lose control of its balance sheet" could be about to come true, and in fact be far worse than expected, because it would mean that not only is the Fed no longer able to control the 10 Year but is concerned about controlling the 2-3 Year sector, a place on the curve that the Fed chairman has typically never had much to worry about.

Incidentally, we wondered earlier why not a single OTR 2 Year bond was tendered to the Fed during today's POMO. Here is you answer: why sell today at 0.44% when you can wait a month and sell them back to Brian Sack at 0.00%

Below we repost the article from May 31, as this topic may suddenly be everything that people are talking about.

 


In Preparation Of The Fed's Last Doubling Down: David Rosenberg Believes QE3 Will Be Nothing Short Of "Operation Twist 2"

 

It is no secret that to a deflationist like David Rosenberg bond
yields have to go lower... Much lower. With the 10 Year flirting with a 2
handle one would think he would be content. Alas no. In fact, as he
suggests in his piece from today, Rosie is convinced that the next
iteration of QE will be nothing short of a redux of the 1961 initiative
to kill the then gold exodus known as "Operation Twist" (recently dissected
by the San Fran Fed). Incidentally it was the same Fed that compared
QE2 to Operation Twist. It is only logical that Rosie would then suggest
that QE3 would be nothing short of a complete clearing of the 10 Year
bond in the market via the Fed in order to anchor expectations that the
10 Year rate would never go up (or reasonably "never") in the
biggest gamble of all: that the Fed will attempt to both control its
balance sheet and target Long-Term interest rates, a mission doomed to
fail...But not like that will prevent the Fed from setting off on such a
mission, especially following today's official confirmation of the
Housing Double Dip (someone page Jim Cramer). As Rosie says: "Now it is
doubtful that the Fed would ever target the long bond. In fact, the Fed
may even want it to be higher in yield to ease the pressure on radically
underfunded pension funds. While the Fed can either target its balance
sheet, which it has been doing with these QE measures, or target
interest rates, it cannot do both at the same time. So the next 'QE' will not be called 'QE' but rather something else — maybe Operation Twist 2 (OT2 — you heard it here first). The Fed would buy up all the 10-year notes needed to clear the market at the target "price" (yield). So depending on supply conditions and demand from the private sector, the
Fed would basically lose control of its balance sheet, but if in return
this policy is the one that blazes the trail for a turnaround in the
housing sector and a durable revival in the economy, so be it
." And keeping in mind that the true unspoken reason for Operation Twist 1
was to terminate the outflow of gold from the US to foreign bank
vaults, we find ourselves agreeing with Rosie that an insane idea such
as OT2 is precisely what the Fed would do to avoid a recurrence of the
1961 gold exodus (and attempt to give housing one last failed boost). As
many birds would be killed with one stone, the only downside, that of a
complete balance sheet implosion following OT2, certainly seems quite
acceptable to a central bank now officially run by sociopaths.

From Breakfast with Rosie:

Since
just about everything that has to do with the economy is either
directly or indirectly priced off the 10-year part of the curve, it
stands to reason that this is the segment that matters most for the
economy.
The 10-year part of the curve is the oxygen tank for
the market and macro backdrop, yet the Fed in its latest QE round
centered its efforts more on the front- and mid- part of the curve.

There
is little doubt that the housing market is suffering from a variety of
obstacles, but what is clear from the consumer survey data is that households do not believe that interest rates will come down any further.
The Fed can only do so much to deal with a de facto vacancy rate of 10%
for the homeownership sector (double the norm) but every little bit
helps at the margin and certainly it can do a much better job at
influencing affordability levels to stimulate some demand growth.

People
need to be convinced that once they make the decision to finance a
purchase that they won't run into a period of rising rates that could
impede their debt-servicing capabilities
. This is where
the Fed can play a role in influencing expectations and it is critical
(this is particularly true for borrowers who are up for variable-terms
mortgages).

Look, we know that: (i) Bernanke is a
disciple of Milton Friedman, and (ii) one of Friedman's classic pieces
of economic research pertained to the 'permanent income hypothesis',
which postulated that it is changes that are deemed to be permanent, not
temporary, that induce a permanent change in economic behavior. This is
why the "permanent" Bush income tax cuts in 2000 worked so much better
than the temporary rebates unveiled in early 2008.

Therefore, at
the margin, in order to do even more to solve the ongoing depression in
the housing market, which continues to pose as a dead-weight drag on the
entire economy, it may well behoove the Fed in its next round of
stimulus, whenever that may occur (but it will, just not at 1,330 on the
S&P 500), to signal to the public its intent to take down and hold
down the most critical interest rate of all for the mortgage market — and that is the 10-year note.

Don't
think for a minute that this not being discussed — Bernanke talked
about embarking on such a scheme, if necessary, when he was still
governor back in 2002:

Because
long-term interest rates represent averages of current and expected
future short-term rates, plus a term premium, a commitment to keep
short-term rates at zero for some time — if it were credible — would
induce a decline in longer-term rates. A more direct method, which I
personally prefer, would be for the Fed to begin announcing explicit
ceilings for yields on longer-maturity Treasury debt ... Lower rates
over the maturity spectrum of public and private securities should
strengthen aggregate demand in the usual ways and thus help to end
deflation. Of course, if operating in relatively short-dated Treasury
debt proved insufficient, the Fed could also attempt to cap yields of
Treasury securities at still longer maturities ... Historical experience
tends to support the proposition that a sufficiently determined Fed can
peg or cap Treasury bond prices and yields at other than the shortest
maturities. The most striking episode of bond- price pegging occurred
during the years before the Federal Reserve-Treasury Accord of 1951.
Prior to that agreement, which freed the Fed from its responsibility to
fix yields on government debt, the Fed maintained a ceiling of 2-1/2
percent on long-term Treasury bonds for nearly a decade.

Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, speech to the National Economists Club, Washington, D.C., November 21, 2002.

This
was otherwise known as 'operation twist'. There is certainly nothing
preventing the Fed from targeting the 10-year Treasury-note any more
than the Fed funds rate. But the funds rate is already near zero and as
such there is no incremental move there that can benefit the economy. But
targeting the 10-year note in much the same fashion is probably worth a
try and if there is anything else we know about Ben Bernanke. It is
that...

(i) he will be late, not early. So, by
the time this comes the economy may well be back in recession, which in
balance sheet cycles tend to occur every three years, so mark 2012 down
in your calendar;

(ii) he is willing to be very
aggressive when the time comes — he has certainly proven that. Back in
2007 or 2008 for that matter, who believed that short rates were going
to vanish entirely and that the Fed would be buying assets by early 2009
?

Now
it is doubtful that the Fed would ever target the long bond. In fact,
the Fed may even want it to be higher in yield to ease the pressure on
radically underfunded pension funds. While the Fed can either target its
balance sheet, which it has been doing with these QE measures, or
target interest rates, it cannot do both at the same time. So the next 'QE' will not be called 'QE' but rather something else — maybe Operation Twist 2 (072 — you heard it here first).

The
Fed would buy up all the 10-year notes needed to clear the market at
the target "price" (yield). So depending on supply conditions and demand
from the private sector, the Fed would basically lose control of its
balance sheet, but if in return this policy is the one that blazes the
trail for a turnaround in the housing sector and a durable revival in
the economy, so be it.

If the Fed were to be concerned
about the impact that any further balance sheet expansion could have on
the U.S. dollar, it could always nudge the short end of the Treasury
curve up in support of the greenback (short-term spreads matter more in
the FX market). By doing this, the Fed would also lend some much-needed
support to the troubled money market fund industry (for more on this
front, have a look at Low Rates Put Pressure on U.S. Money Markets Funds
on page 13 of today's FT). So much can be accomplished with such a
policy—the upside potential will be worth it.

However,
politically, the Fed has to wait for the next downturn in economic
activity and reversal in the stock market so that those on Capitol Hill
that are lamenting the Fed's interventionist efforts end up begging for
more. This could come sooner than you think, but likely not until we see
the whites of the economy's eyes — and early signs are showing a
visible sputtering in growth.

One last item to note. If, say,
the 10-year note were to be capped at 2 1/2%, where it was at ahead of
the QE2 program last fall, compared with the current 3%-plus level, the
total return for a 10-year strip would come to over 10% in a 12-month
span. Now put that in your pipe and smoke it!

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baby_BLYTHE's picture

they are going to keep printing. I don't know why anyone still doubts this

nope-1004's picture

So by capping the short end of treasuries, the objective is higher bond yields, and thus inflation?  Can someone help me with this?

If that's correct, then the USD is on even thinner ice right now, is it not?

 

gmrpeabody's picture

That isn't ice..., it just really cold water.

mkkby's picture

This is actually funny.  As long as the Fed, or China, or some idiot is willing to buy treasuries at absurdly low yields the US gets essentially free money.  It's never gonna be paidback -- this is just Greece on steroids. Every dollar lent to the US is free military, welfare, social security and everything else.  Bring on free health care, please!

The US is able to spend double the taxes taken in.  As a taxpayer I love the half off sale.

falak pema's picture

That's how the mafia hooks the junkies...free powder...until he's hooked...then you pull the plug and he's cooked good. Classic ploy. The payout is huge. 

masterinchancery's picture

The free booze is great, but the hangover is a killer.

tiger7905's picture

Yra Harris believes they msy also fix long term rates.

http://goldandsilverlinings.com/?p=1219

Tuco Benedicto Pacifico Juan Maria Ramirez's picture

As in "half off" your purchasing power since 2001!?

 

Tuco Benedicto Pacifico Juan Maria Ramirez

XPolemic's picture

Reminds me of an old saying:

If you borrow 1000 bucks and can't pay it back, you have a problem.

If you borrow 10,000,000,000,000 bucks and can't pay it back, your creditors have a problem.

Urban Redneck's picture

How is the half-off food and gasoline working?

buzzsaw99's picture

The Corleone family wants to buy you out (of the t-bond market bitchez).

http://www.youtube.com/watch?v=aiZYhhE1HVU

Concentrated power has always been the enemy of liberty.'s picture

higher bond yields would indicate investors wanting compensation for higher inflation expectations.  But it's usually a lag on the way up due to inability of the fed to push the brakes on the economy.  Volker got ahead of it and produced a positive real return and killed inflation for a bit.

But it's not happening that way this time.  It's wag the dog.  The solvency issues will push the long end up but not for inflation expectations.  Instead for hyperinflation, loss of confidence.

Bam_Man's picture

"So by capping the short end of treasuries, the objective is higher bond yields, and thus inflation? Can someone help me with this?"

No, the objective is to give the banks a steeper yield curve and thus a more lucrative carry trade.

The Fed is clearly in the process of "giving up on a housing recovery" by deciding to re-capitalize the banks over a longer period of time via a UST carry trade.

chumbawamba's picture

"The Fed is clearly in the process of 'giving up on a housing recovery' by deciding to re-capitalize the banks over a longer period of time via a UST carry trade."

In other words, it's time to kickstart the next phase of The Plan.

I am Chumbawamba.

swissinv's picture

riding the yield curve

 

XPolemic's picture

No, the objective is to give the banks a steeper yield curve and thus a more lucrative carry trade.

That would imply that there are still borrowers to take the long end, and that people will pay their mortgage.

swissinv's picture

just listen to good Tyler and focusing on the 10Y

Banjo's picture

Wasn't this article saying the Fed is going to buy the 10yr bond and allow shorter term less than 2yr bonds to rise?

 

trav7777's picture

I don't know who this idiot is in this article who thinks that people aren't buying houses because they are worried about fking future interest rates rising!??!

People aren't buying houses because they are POOR credit risks due to lack of savings and income.  There are plenty of NINJAs willing to robobuy as many houses as necessary, but they can't be lent to at ANY rate.

We LONG ago passed through all of the ablebodied homebuyers.  There are too many houses and too few buyers.  The market must clear to find a real level of demand.  Gov't has been pumping the housing market for well over a decade.  That distortion will take a LONG time to burn through.

For someone who has savings and income, looking at locking up 30 yrs of interest payments for an "asset" that has shown to be a crapshoot is not a good decision.  The market will find a price level where houses sell; we are far too high for that and rates mean jackshit when the income can't pay any coupon

dick cheneys ghost's picture

Shiller says housing could go down for another 20yrs........and some are saying another 8 million foreclosures yet to hit....

ZeroPower's picture

Exactly right trav, for those able to anyway, absolutely no reason to try their hand at the property market again, after virtually everyone who bought in '06 and after got literally hosed. Not to mention the flippers, but fuck them in the first place.

As for a further 20yr housing prices depression, unlikely as i believe prices shouldnt take that long to bottom (what is that, 5 adminstrations?) but clearly these aren't the droids were looking for.

Bicycle Repairman's picture

Prices will take 20 years to bottom, because that's what they want.  The government will keep intervening to slow the slide.

wintermute's picture

It's not even that good. 4 million of the foreclosures you mention will be stalled in "quiet title" cases clogging the legal system for decades.

Fannie, Freddie, JPM, Citi, BoA et. al. have subverted the whole system of property transfer in order to churn, secondary market and securitize mortgages.

Denninger has been pointing out this financial H-Bomb for a long time.

http://www.market-ticker.org/akcs-www?post=188065

fuu's picture

The government has been pushing on that string for 20+ years according to that median home price / gold chart from yesterday.

macholatte's picture

the so called "double dip" in housing is just a blip on the chart because there was no serious recovery anyway so the entire discussion about housing is really just blather.

http://www.jparsons.net/housingbubble/

Interest rates are a factor, but not the primary driver. People do not believe that there is a reason to to buy a house or pay their mortgage, so they don't.  And all the hype did not change sentiment.  The country would have been way ahead of the game had TPTB simply worked a way to reduce mortgage principle for main street instead of the continual game of feeding the dead cats, Freddie and Fannie, etc. ..... but if mom & pop actually got some help there wouldn't be any way to swindle the tax payer.

 

 

Ergo's picture

Jobs, Jobs, Jobs --- No job security means can't buy a house.  The Fed fails to realize that structural economic problems of this magnitude can't be cured with loose money to the elite.  The issues here are fairness and rule-of-law.  And we threw those out. 

Renting is cheaper, and it let's you leave if you have trouble.  And there are lots of rentals out there, especially from people who are trying to avoid a foreclosure, and are smart enough to turn their house into a tax deduction if they do have to sell for a loss.  (can't deduct losses from your residence, but you can from rental properties, or so I hear). 

 

NotApplicable's picture

The Fed fails to realize? HA!

These people have built entire careers around apathetically clinging to false belief systems. Why? Because it works for them. There is nothing to gain by rocking the boat (that just splashes water on everyone else, making them mad at you).

In other words, lack of realization is their success, not their failure.

Ergo's picture

Good points.  Or, maybe the Fed realizes all too well, and their purpose is to loot as absolutely much as possible for the elite few. 

Tuco Benedicto Pacifico Juan Maria Ramirez's picture

Bingo!!!!!!!

 

Tuco Benedicto Pacifico Juan Maria Ramirez

Lord Koos's picture

Of course... but that would be SOCIALISM.  AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAH!

1100-TACTICAL-12's picture

That's the way I see it also. Everyone who has credit & want's a house has one..

mkkby's picture

Maybe you are right, Trav.  Idiots are in the majority and they buy houses because they are approved for a large enough loan.  Smarter people know rates can't be manipulated forever.  And buying when rates are historically low is a trap, which will cause your asset value to lose 10% for every 1% rate increase.

taxpayer102's picture

@trav7777
In this area of Georgia the top reason homes aren't selling is due to buyers not having adequate credit to qualify for a loan.  "Under contract" signs frequently get replaced with a new for sale sign when the buyer isn't able to qualify.
About 60% of homes that do sell here are bought by America's new middle-class - active duty military, civil service and military contractors.

max2205's picture

Yield curve to go vertical from 5 yr to 30 yr

Boston's picture

Very possible.

After riding the 7-10yr notes up for three months, I got out and put the entire position into sub-5 year notes.

If this is true, I will thank my lucky stars and just ride the curve down over the next 6-12 months.

 

chdwlch1's picture

Can't help but think of Top Gun...

Maverick-"He's going vertical, so am I"

Goose-"We're going ballistic Mav go get him"

Maverick-"No way Jester, You're mine"

Goose-"Come on Mav do some of ..."

lizzy36's picture

Great.

Now i have a visual of Bernanke and Gross playing operation twister, and Leisman watching from the sidelines.

Even my visuals are being perverted. DAMN.

hedgeless_horseman's picture

Cramer has the spinner in hand and he is again saying, "Everyone gets long here and nobody gets hurt."  This time, however, he means Treasuries, not stocks.

How is the SEC's investigation into Cramer's company, The Street, proceeding?  Was his "get long" call the Get Out of Jail Free card he hoped it would be?  Seems to be so.

chumbawamba's picture

"'Everyone gets long here and nobody gets hurt.'  This time, however, he means Treasuries, not stocks."

Oh, thank goodness, because based on Lizzy's comment I thought you were talking about cocks.

I am Chumbawamba.

Cognitive Dissonance's picture

With everyone in bed with the twisted Fed why not have some Twister Ponzi fun?

The pictures on the night table are a nice touch Ben.

chumbawamba's picture

That can't be Ben's bed.  There aren't any butt plugs anywhere.

I am Chumbawamba.

bigdumbnugly's picture

ohhhhhhhhhhh

all this time i thought congressman frank was talking finances when he asks for a hand out of the red and into the green.

i shoulda known...

 

Tuco Benedicto Pacifico Juan Maria Ramirez's picture

Ever notice how Barney Frank always talks like has something in his mouth like a cigar or something??

 

Tuco Benedicto Pacifico Juan Maria Ramirez

GeneMarchbanks's picture

I swear that is Timmy in the picture!

I see nobody giving props to Rosie. I mean, the man called it!

Problem Is's picture

Lil' Wanker Timmay? Nice call...