What the Fed twisteth, Treasury issueth away
So much for policy coordination. Just days after the Treasury published a note touting its progress in lengthening the average maturity of its outstanding bonds, the Fed decided to extend Operation Twist – a policy aimed at doing the exact opposite. By selling an additional $267 billion in short-dated bonds to buy long-term ones, the Fed is trying to take Treasuries with longer maturities out of the market, to lower yields and entice investors to take on more risk.
In a narrow sense, the Treasury’s approach is perfectly reasonable: U.S. interest rates are at historic lows, so it stands to reason that the government should lock in that low cost of borrowing for the longest period possible. However, in the context of an economy that remains exceedingly weak – and where the only source of stimulus appears to be a reluctant central bank – the move could be viewed as somewhat incongruous.
Fed Chairman Ben Bernanke himself addressed the issue when he was asked during the post-meeting press conference whether it would make sense for the U.S. government to issue more longer-term bonds given the current low-rate environment.
The government is very gradually increasing the duration of its debt, the Treasury I mean, it’s been doing that for some period of time. There’s a bit of an issue here which is that, what the Federal Reserve is doing, with the program we announced today, the maturity extension program, is we’re taking longer-term debt off the market in order to induce investors to move into other assets and to lower longer-term interest rates. To the extent that the Treasury actively sought to lengthen the duration of its borrowing it would to some extent offset the benefits of those policies. So, my understanding of what the Treasury is doing is that they have a plan, they’re sticking to that plan, and therefore on the margin the effects of the Fed’s actions can be felt.
That may be the case. But it still seems odd for the two institutions charged with the stewardship of the economy to be working at apparent cross-purposes. All the more so if, as Bernanke himself argued in 2003 as a Fed board governor giving advice to a stagnant Japan, tough situations call for “explicit, though temporary, cooperation between the monetary and the fiscal authorities.”
The Bank of International Settlements has also highlighted the idiosyncrasy. In a March paper that looked to quantify the effects of the Fed’s first Operation Twist, the BIS said:
The effectiveness of the Federal Reserve asset purchase programmes depends on Treasury debt management policy. When the Federal Reserve acts to lower yields for longer-dated bonds and the Treasury has large longer-term borrowing needs, a conflict of interests may emerge.
Wait a second. Isn’t a strong economy also in Treasury’s interest?