Operation Twist: The Battle for Lower Interest Rates

by Kevan McCormack, Senior Director

Some of you may have heard about the Feds’ new offensive on Interest Rates affectionately called “Operation Twist”.  For those of you who have not, Operation Twist is not a new idea, simply a recycling of an old 1960’s experiment.  The policy was approved on September 21, 2011 and will start to be implemented in October 2011 and run through June 2012.  This time around, the Fed will begin selling $400 billion of short and medium term treasury bonds in favor of buying longer term treasury bonds with the expected effect of bringing down long-term interest rates while keeping short-term rates essentially unchanged.  As compared to the 1960’s campaign, this time around the Fed is deploying about 50% more capital as a proportion of today’s gross domestic product (i.e. about 2.7% compared to 1.7% in the early 60’s).  This so called “Twist” move is the Fed’s answer to their vow to keep interest rates low through mid-2013.

So what is the likely effect of this move on actual interest rates?  In the 1960’s campaign, Operation Twist had a very nominal effect on rates of about 0.1% to 0.2% at the time and was not very effective to get any positive movement in the economy.  So with this round being twice as large in relation to GDP, does that mean there will be a 0.25% movement in long-term rates?  Not so fast!  In 1960’s, the 30-year FHA Mortgage rates were in the 5.25% range.  Today, the equivalent 30-year Conventional Mortgage Rates are around 4%.  So with rates more than 20% lower than the last time this was attempted, it can be argued that any positive effect on interest rates will be muted with rates at already historic lows.

The real question is, will Operation Twist create any opportunities in commercial real estate?  Interest rates have already been at historical lows for almost a year now, and there has been little positive impact in commercial or residential lending volumes.  Will another 20bps really do anything?  The problems plaguing commercial real estate finance today seem to ones related to value, not necessarily interest rates.  While interest rates are one component of imputed value derived from a “Cap Rate”, the other components of a Cap Rate (i.e. risk adjusted returns, etc…) seem to be having a more dominant impact on value today.  These other dominating components of Cap Rate value have a closer relationship to the health of our economy encapsulating metrics such as GDP growth and inflation that lower interest rates are not going to solve.  Since lower interest rates have an inflationary effect, in the long-term, interest rates and inflation have an inverse relationship and will have a null effect.

The Fed’s efforts to win on the battlefield of this bad economy has been like watching a infantry soldier trying to take down a Panzer with a .22 caliber pistol with just one clip left.  The Fed’s primary weapon (i.e. interest rate manipulation) has been rendered impotent.  Our administration (not the Fed) would be better off fighting the battle with a bigger weapon of reinforcing consumer confidence in the value of the dollar and our overall economy by cutting our national debt.  Rather than dancing around the issues, our government needs to just admit the problem and take a sledge hammer to it!  Until this happens, everything else you read is just noise consisting of simple misdirection from the real battlefront.

Want to learn more, contact Kevan McCormack, Senior Director

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