Operation Twist Expectations (or LSAD) Returning With A Vengeance Explains Today's Moves In Stocks And Gold
Whether the Fed will upgrade QE2.5, or "ZIRP through mid-2013", to QE3, or Operation Twist, the form we have been predicting it would take since May (and here), is still unknown: very few people know what Bernanke will say on Friday, minutes after the first revision to Q2 GDP reveals a sub-1% number. What is known is that while cross-asset correlation has soared over the past few days, the biggest driver of stocks over the past few days has been nothing but the 2s10s30s butterfly, which in turn is driven by On and Off rumblings of Bernanke doing the Twist. And here is the rub: when the Fed announces Twist it will be extending duration, it effectively means selling everything 10 Year and older (yes, QE3 could very well be LSAD or Large Scale Asset Dumping instead of LSAP). The goal of this action: make the 2s10s will go vertical and to pancake the 10s30s: a move that the butterfly is now indicating it is once again pricing in - today alone we have seen a massive 15 steepening in the butterfly: a nearly 20% move in the curve. It also explains why gold is being sold off today, because simplistic investors believe that without an actual balance sheet expansion, the Fed will not be diluting paper. Completely wrong: it will merely do so synthetically, from a duration basis. Furthermore, the market will very soon read through the Fed's intention which will be predicated entirely on asset rotation and not on incremental fiat capital. The final outcome will be QE4 where the Fed will have to match the synthetic duration extension with actual cash bond deliverables, namely monetizing bonds, a move which will be even more critical once the deficit spend starts soaring again in the next 3 months. And when it does, it will have to do so double time, to make up not only for previous synthetic exposure extension, but for future priced in moves. In other words, nothing has changed, and we fully expect stocks to soar if indeed Bernanke mentions "duration extension", together with yet another gold dump. The issue is that Op Twist in the proposed format would be physically limited by the amount of 10 Year+ bonds held in the Fed's SOMA. At last check it was not that many at all. So any surge in stocks will be albeit both painfully transitory.
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