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Corrupt Government Title: A 50-Year Bond? What One Fed Option Could Look Like [Bernanke's Getting Desperate] With the Federal Reserve widely expected later this month to unveil the latest weapon in its easing arsenal, expectations are ranging from Operation Twist, a variation called Operation Torque, and to a 50-year Treasury bond. Getty Images A 50-year bond? While the idea seems radical even for a central bank carrying a $2.8 trillion balance sheet, the idea of the Fed going that far out on the yield curve in a desire to stimulate the economy is drawing market chatter. The purpose of the bond would be to extend the duration of the Fed's otherwise short-term debt portfolio. In theory it would take the pressure off the central bank from having to roll over its debt on a continual basis. Buyers would be the Fed and perhaps pension funds and those who desire a higher yield and longer-term debt. Rumors have floated before about a possible 100-year bond but one has never come to fruition. "This is a viable option for them," insists Jeff Kilburg, senior development director at TreasuryCurve, an online trading platform. "They're able to extend that debt, that's the whole key. Clearly the global economy is an open wound. This is an important tactic that would instill some confidence, clarity and vision and provide a template for the European problems." For the record, a well-placed Treasury source dismissed the idea of the department and the Fed working to develop a 50-year product. But the discussion is symbolic of the race among investors to discern the Fed's next move now that the second round of quantitative easing —QE2—is over and the US economy is teetering on re-entering another recession just two years after the last one ended. Jeff Cox Senior Writer CNBC.com Kilburg maintains it is "an option (Fed Chairman Ben Bernanke) is considering," despite the Treasury official's denial. Bernanke is speaking Thursday afternoon in Minnesota, which will be closely watched but unlikely to reveal new Fed strategy plans (CNBC.com will carry the speech live at 1:30 pm ET). The Fed's Open Market Committee meets Sept. 20-21. "The Fed and the Treasury are talking not on a weekly basis but a daily basis," he says. "The fragility of Europe has shaken the faith of the Fed. When Bernanke said they're going to keep rates the same for two years, I don't think the equity market grasped the depth of that comment. The bond market clearly did." Since the last Fed meeting, government debt has continued to be gobbled up by investors looking for safety and convinced that the economic growth is likely to stay anemic. The Fed, meanwhile, is expected to announce, or at the very least hint at, new measures to stimulate the economy. Probably the most popular theory is that the Fed renews Operation Twist, a 1960s-era measure in which the central bank sells short-term debt and buys long-term debt in an effort to flatten the yield curve and drive down long-term rates. Much of the speculation is that the Fed will buy in the seven- to 10-year range. But that talk itself has taken a different turn lately, with sentiment growing that the Fed will go out even longer on the yield curve , though not perhaps as far as Kilburg's 50-year anticipation. RELATED LINKS Current DateTime: 08:16:26 08 Sep 2011 LinksList Documentid: 44427611 'Twist' on TapRecession Still On; Fed's EvansWhat Can Fed Really Do? Morgan Stanley, in fact, has put its own label on the Fed's next move, calling it "Operation Torque" because more force will be applied than just driving down borrowing costs. By buying bonds in the 30-year range, the Fed will reduce supply and thus spur investment across a whole range of asset classes because investors won't have to worry about long-term credit risk. In a lengthy note speculating on what "Operation Torque" would entail, Jim Caron, Morgan Stanley's widely followed head of global interest rate strategy, said its main benefit would be in taking long-term debt off the market. That would lower risk premium as well as "the borrowing cost of credit, ultimately benefiting the broader economy." "The goal of Operation Torque is to remove duration supply from the market, and not simply to push yields lower," he added. "With less supply in the market, risk premiums for spread products should decrease, driving easier financial conditions." The average duration of the Fed's System Open Market Account (SOMA) holdings is 6.25 years. It holds $144 billion that will mature over the next year and nearly $300 billion that will mature in less than two years, according to data from Bank of America Merrill Lynch. Under Caron's Torque scenario, the Fed would sell all its debt less than two years from maturity and buy in the 25- to 30-year sector, which is longer than the consensus opinion of seven to 10 years. He thinks the benefits will come in "lower credit rates, lower borrowing costs, lower mortgage rates" and other areas. The biggest obstacle for the Fed to convince the market that Torque or Twist will work is making the case that interest rates are the primary barrier to spending and economic growth. For instance, despite the second-lowest mortgage rates on record, housing continues to languish and mortgage applications have declined for three consecutive weeks. "Does the Fed think that the 10-year note with a one-handle (sub-2 percent yield) is what's holding back the economy?" says Michael Pento, an economist and president of Pento Portfolio Strategies in Parsippany, N.J. "This is a balance sheet recession. A balance sheet recession has to be unwound over years if not decades, especially one of this size. If (lowering rates) is going to engender economic activity and save us from this malaise I'd be shocked." The Fed also will have to convince the market that holding long-term bonds is a good idea when inflation continues to rise and poses perhaps the next big threat to the economy. Pento said the Fed would "be even more insolvent" if it took on longer-term debt that it would have to hold to duration should prices fall and yields rise, as they would if inflation accelerates. The concern is echoed in the bond industry. "I don't agree with the need or the hoped-for result of Twist. Exit, should it ever come to pass, would be impossible," says Kevin Ferry, president of Cronus Futures Management in Chicago. "If hold-to-maturity is the real exit strategy, we have walked far enough out the plank. A lot of questions, very few answers. Tossing around a catchy name without examining the policy details won't cut it."
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