Market expects Operation Twist in September

Reuters

By Emily Flitter

NEW YORK (Reuters) - Bond investors see Federal Reserve action to boost the flagging U.S. economy as practically a done deal after Friday's dismal jobs report.

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Government data showing the economy failed to create new jobs last month heightened speculation the Fed will launch a program this month to pump money into the economy by pushing down long-term borrowing rates.

The move, known to some in financial markets as Operation Twist, would probably involve the Fed selling shorter-dated Treasuries it holds its balance sheet and buying longer-dated bonds.

The Treasury market appeared to price in greater chances of this after the jobs report, with 30-year long bonds surging 3 points in price.

"Following today's worse-than-expected jobs report, we now look for the Federal Open Market Committee to announce a lengthening of the average maturity of the Fed's balance sheet at the September 20-21 meeting," Jan Hatzius, chief U.S. economist at Goldman Sachs in New York, wrote in a note to clients.

Goldman's call echoed in the Treasury market on Friday, with a flattening of the yield curve as traders increased positions in longer-dated bonds at the expense of shorter maturities.

Some analysts said even without the dismal jobs data the Fed's move would have been inevitable.

"We thought they were going to do it in August," said Ira Jersey, interest-rate strategist at Credit Suisse in New York." "But I guess with some of the operational issues it raises they wanted to wait."

Operation Twist would take some fancy footwork, Jersey said, with the New York Fed likely having to hold two auctions in a single day.

In the first, the Fed would sell shorter dated securities. It would then hold a second to buy bonds of longer maturities from primary dealers. Both auctions would settle the following day.

Hatzius, at Goldman, said such an operation would ultimately remove so much longer-dated debt from the market its effect would be almost as big as the Fed's last major easing program.

Referred to by many as QE2, the Fed bought $600 billion in Treasuries.

"This type of operation would be the equivalent of 80-90 percent of QE2 in terms of duration risk removed from the market," Hatzius said.

(Additional reporting by Richard Leong; Editing by Burton Frierson and Leslie Adler)