What Is Operation Twist?
Key takeaways
– Operation Twist is a Fed policy that flattens the yield curve by selling short-term Treasuries and buying long-term Treasuries—aiming to lower long-term interest rates without expanding the Fed’s balance sheet. (Investopedia; Federal Reserve)
– It was first used in 1961 and revived in 2011 (often called the Maturity Extension Program). The policy contrasts with quantitative easing (QE), which expands the balance sheet through net asset purchases. (Investopedia; Federal Reserve Bank of San Francisco)
– Intended effects: lower long-term borrowing costs (mortgages, corporate debt), stimulate investment and consumption, and reduce curvature of the yield curve. Limitations include modest effects if market expectations or inflation risks dominate and potential distortions in market functioning. (Fed research; Treasury yield data)
Understanding Operation Twist
What it is and why it’s used
– Operation Twist is a “twist” of the yield curve: the Fed sells short-duration Treasury securities and uses proceeds to buy longer-duration Treasury securities. Selling short-dated paper tends to push short-term yields up slightly; buying long-dated paper raises long-term prices and pushes long-term yields down. The net goal is a flatter yield curve with a lower term premium on long rates.
– It is typically used when the Fed’s policy rate is near zero and cannot be cut further, but additional monetary impetus is desired by lowering long-term rates (e.g., to support mortgages, corporate borrowing, and investment).
Historical use
– 1961: Media-labeled “Operation Twist” responded to post-recession conditions—sales of short-term and purchases of long-term Treasuries to influence rates.
– 2011: The Fed announced a maturity extension program that sold short-term securities and bought long-term Treasuries to lower long-term rates while keeping the balance sheet size unchanged. (Federal Reserve Bank of San Francisco)
Important: how Operation Twist differs from QE
– Balance sheet: Operation Twist is sterilized—sales of short-term securities finance purchases of long-term securities, leaving aggregate Fed holdings roughly constant. QE is expansionary—net purchases increase the Fed’s balance sheet and reserves.
– Mechanism focus: Operation Twist redistributes duration across the Fed’s portfolio to change yields by affecting supply/demand at different maturities, while QE also increases bank reserves and can influence broader liquidity and risk premia.
Operation Twist mechanism (step-by-step)
1. Policy decision and communication
– Fed announces intent to sell X amount of short-term Treasuries and buy Y amount of long-term Treasuries over a defined period, including target maturity bands (e.g., 1–3 years vs. 6–30 years) and likely sizes.
2. Executing sales and purchases
– The Fed sells short-term Treasury bills/notes in the open market (or lets them roll off as they mature) and uses proceeds to purchase longer-term Treasury notes and bonds.
3. Market reaction
– Selling short-term paper increases its supply to private investors and tends to push short-term yields slightly higher; buying long-term paper increases demand, raises prices, and pushes long-term yields lower.
4. Transmission to economy
– Lower long-term yields reduce borrowing costs for mortgages and many fixed-rate corporate loans, support asset prices (equities, REITs), and can increase consumption and investment.
5. Monitoring and adjustment
– Fed tracks yield curve slopes, mortgage rates, credit spreads, lending activity, inflation expectations, and financial stability metrics, and adjusts operations as needed.
Special considerations and limitations
– Magnitude: The effect depends on the scale of activity relative to market size and investor expectations. Small operations may have modest market impact.
– Expectations and signaling: Much of the effect is through expectations—if markets believe the Fed will keep policy rates low, that anchors short-term yields. Operation Twist works best when it credibly targets long-term rates beyond what expectations alone produce.
– Inflation and risk premia: If inflation expectations rise or risk premia widen, downward pressure on long-term yields can be offset.
– Market functioning: Aggressive maturity transformation can distort market liquidity and pricing in certain maturities, potentially increasing volatility in other asset classes.
– Legal and operational constraints: The Fed is limited by mandates and operational authorities; communications and coordination with the Treasury matter (e.g., concerns about market functioning, issuance calendars).
– Not a standalone cure: Operation Twist is a tool to influence term structure, but fiscal policy, credit conditions, and global factors also determine macro outcomes.
How to measure whether Operation Twist is working
– Yield curve slope: watch the 10-year minus 2-year yield (or 10-year minus 3-month) and changes in the 10-year yield itself. (U.S. Treasury Daily Yield Curve Rates)
– Mortgage rates and mortgage-backed securities (MBS) spreads: declines indicate transmission to household borrowing costs.
– Bank lending and corporate issuance: volumes and spreads for corporate bonds and bank lending rates.
– Fed funds futures and market-implied rate paths: confirm consistency between short-rate expectations and Fed communications.
– Market liquidity and volatility in Treasury auctions and secondary markets.
Practical steps — for policymakers (how to design and execute)
1. Define objective and metrics
– Specify targeted maturities, desired change in long-term yields, and measurable KPIs (e.g., 10y yield target range, mortgage rate target).
2. Size and duration plan
– Determine the total notional to be shifted, pace of operations, and timeframe; calibrate relative to Treasury market size and outstanding float.
3. Communicate clearly
– Announce the program, rationale, duration, and contingencies. Transparency reduces uncertainty and amplifies effectiveness via expectations.
4. Coordinate operationally
– Use market operations teams to execute through primary dealers; design auctions or outright transactions as appropriate. Consider rolling maturities vs. outright sales.
5. Monitor market functioning and side effects
– Track liquidity, spreads, and potential crowding in long maturities. Be ready to pause, adjust pace, or complement with other tools (e.g., QE or forward guidance).
6. Exit strategy
– Plan for how and when to unwind or end operations to avoid market disruption—signal timeline in advance where possible.
Practical steps — for investors and market participants (how to respond)
1. Reassess duration exposure
– Expectation of lower long-term rates suggests longer-duration assets (bonds, duration-sensitive ETFs) could benefit; but be mindful of policy credibility and inflation risks.
2. Watch yield-curve trades
– Strategies that profit from a flatter curve (e.g., paying short protection, receiving long rates) may be appropriate for sophisticated investors.
3. Sector positioning
– Rate-sensitive sectors—housing-related assets (mortgage REITs, homebuilders), utilities, and long-duration growth stocks—may perform well if long rates fall.
4. Monitor credit spreads and MBS
– Lower long-term Treasury yields can compress investment-grade and high-yield spreads, but watch liquidity and default risks before extending credit exposure.
5. Hedging and contingency planning
– Use options or other hedges against a reversal (inflation surprise or shifting Fed stance). Don’t over-leverage duration positions.
6. Follow Fed communication and data
– Closely track Fed statements, minutes, and economic data (inflation, payrolls, unemployment) that affect the probability of continued operations.
Risks to watch
– If markets interpret Operation Twist as insufficient relative to needed stimulus, longer-term yields may not move materially.
– Unintended market distortions (crowded trades, reduced liquidity in long-dated securities) can raise systemic risks.
– If inflation expectations rise, long-term yields could increase despite Fed purchases, undermining intended effects.
Bottom line
Operation Twist is a targeted, balance-sheet-neutral tool to lower long-term interest rates by reallocating the maturity composition of the Fed’s holdings. It can be a useful policy when short-term policy rates are at the effective lower bound and the Fed wants to affect term premiums and long-term borrowing costs. Its effectiveness depends on scale, market expectations, and broader macro forces; it is complementary to (but different from) QE and forward guidance.
Sources and further reading
– Investopedia. “Operation Twist.” https://www.investopedia.com/terms/o/operation-twist.asp
– Federal Reserve Bank of San Francisco. “Operation Twist and the Effect of Large-Scale Asset Purchases.” (research overview)
– Federal Reserve Bank of St. Louis. Effective Federal Funds Rate data (FRED).
– U.S. Department of the Treasury. Daily Treasury Yield Curve Rates. https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.