At the upcoming meeting at Kansas City Fed's in Jackson Hole, Wyoming on August 26th – 28th, Bernanke and the Fed members announced at the same meeting in 2010 the QE2 program and many investors reacted to it by pushing down the long term bonds such as the 10yr and 30yr (see below).
However, ever since last month’s announcement of the Fed to keep rates low until 2013 investors have pushed down the 10yr and 30yr to historic lows. In 1961 the Fed put in place Operation Twist to artificially flatten the yield curve in order promote capital inflows and strengthen the dollar. However, the down fall of the program in 1961 was the duration of its intent.
Now with hopefully learning from the trails of 1961 the Fed might implement a form of QE3 by instilling another Operation Twist but with a few more enhancements. Since the intent of such a program is to instill capital inflows by more lending and tighten the short term rates the Fed might adopt to flatten out the long term rates between 10-30yr but how much lower can these yields go. Already the market currently has pushed them to historic lows and the ramifications are being felt throughout the banking sector as a refinance race has been kicked off and prepayments are inching up almost on a weekly basis.
The Federal Reserve Bank of San Francisco published a paper in Feb 2011 talking about the effects of operation twist on the last QE measure (take a look). Hopefully this week will come quick and with it a plan.
