Bloomberg News

Pimco, Goldman, RBC Say Bernanke to Revisit Operation Twist

September 02, 2011

Sept. 2 (Bloomberg) -- The Federal Reserve will seek to narrow the difference between short- and long-term borrowing rates as early as this month as stalled employment growth threatens the recovery, according to Wall Street bond dealers and the world’s biggest manager of fixed income funds.

Pacific Investment Management Co., Goldman Sachs Group Inc. and Royal Bank of Canada said they expect the central bank to announce plans to raise the average maturity of its bond portfolio by selling shorter-term debt and reinvesting proceeds from maturing securities into longer-term bonds. The Fed purchased $2.3 trillion of debt since 2008 in two previous rounds of what’s become known as quantitative easing, or QE, to drive rates lower and help spur growth.

“That will be the focus for the Fed in terms of policy change come September,” Bill Gross, manager of Pacific Investment Management Co.’s $245 billion Total Return Fund, said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “We would stick in the five- to 10-year area” to take advantage of demand from the Fed, Gross said.

Fed Chairman Ben S. Bernanke has cited extending the average maturity as one of monetary stimulus tools available to policy makers. Economists with the Fed’s regional bank in San Francisco wrote in April that “Operation Twist,” a 1961 initiative by the central bank and President John F. Kennedy’s administration, spawned a 0.15 percentage point reduction in long-term Treasury yields.

Curve Flattens

The yield on 10-year Treasuries fell 13 basis points, or 0.13 percentage point, to 2 percent at 3:07 p.m. in New York, according to Bloomberg Bond Trader prices. Yields on two-year notes rose 2 basis points to 0.20 percent, narrowing the so- called yield curve to 1.80 percentage points.

“We are now assuming that the Fed will” sell shorter maturity Treasuries to buy those due later, Michael Cloherty, the head of U.S. rates strategy for fixed income and currencies at Royal Bank of Canada in New York, wrote in a research report. Goldman Sachs said that “following today’s worse-than-expected jobs report,” the firm expects the Federal Open Market Committee to announce a lengthening in the average maturity of its holdings at the Sept. 20-21 meeting.

Payrolls were unchanged last month, the weakest reading since September 2010, after an 85,000 gain in July that was less than initially estimated, Labor Department data showed today in Washington. The median forecast in a Bloomberg News survey called for a rise of 68,000. Hourly earnings and hours worked both declined. The August data included a 48,000 drop in information industry jobs, mostly reflecting striking Verizon Communications Inc. workers.

Stimulus Risk

More stimulus from the Fed may not be beneficial because it risks a political backlash that could threaten to undermine the central bank and weaken the economy by driving up commodity prices, Mohamed A. El-Erian, Pimco’s chief executive officer and co-chief investment officer with Gross, said today on Bloomberg Television’s “In The Loop” with Betty Liu.

“The balance between the benefits and cost and risks has changed in an adverse manner,” El-Erian said. “At the end of the day we will not be solving anything. We’ll just be undermining the economy and a critical institution for the well being for America.”

Governments should be focusing on creating growth rather than reducing debt, Gross said. “To do it right now is almost suicidal,” he said.

The economy expanded at a 1 percent pace in the second quarter following a 0.4 percent gain in the first three months of the year, the Commerce Department reported last month. Consumer spending grew 0.4 percent, the smallest increase since the last three months of 2009.

U.S. government bonds returned 2.8 percent in August, the most since December 2008, as investors bet on slower growth and sought a refuge from global financial market turmoil, according to a Bank of America Merrill Lynch index.

--With assistance from Tom Keene in New York. Editors: Dave Liedtka, Paul Cox

To contact the reporter on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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