March 17, 2021
In 1960, the number one hit on the singles chart was recorded by a great singer named Chubby Checker – and with it came a two-year dance craze based on the song – “The Twist.” As you might imagine – and for those that did not live through that time – the dance is done with arms are held away from the body, bent at the elbow – and the hips, torso, and legs rotate back and forth, with the balls of the feet grinding on the floor. I’m not sure if the dance will be coming back any time soon (although it does sound like a good exercise), but the Fed may be getting the urge to do the Twist again – and investors need to be kept aware.
One can’t help but wonder if the original ‘Operation Twist’ was named from the then-current dance craze. In 1961, the Federal Open Market Committee (hereinafter, the FOMC) tried to strengthen the dollar in the hopes of stimulating cash inflows into the U.S. economy in response to the nascent recovery from an economic recession that followed the end of the Korean War. With the objective of promoting spending, the FOMC flattened the treasury yield curve by selling short-term debt and used the proceeds to purchase long-term Treasury debt. In this sense, in contrast to quantitative easing, Operation Twist does not expand the Fed’s balance sheet, therefore, making it a less aggressive form of a dovish policy.
As current market observers know, there has been a relatively significant (percentage-wise) rise in the US treasury yield curve of late; at year-end 2020, the 10-year bond’s yield was 0.9%. Last week, the exact bond yield exceeded 1.5%. It may come as a surprise to know that bond yields are back where they were in January and February of 2020, right before the pandemic came into full force. With this quick rise in rates, there has also come expectations that Fed Chairman Powell would “do something” to stop the increase. In recent comments, Powell noted that with many people still out of work from the pandemic and therefore the labor market still a long way from “full employment,” the rate rise would likely be temporary in nature. He emphasized his intention of maintaining its short-term rate target close to 0% and monthly purchases of Treasury and Agency securities of $120 billion. To the comfort of the market, these policies will stay in place, he said, until full employment is attained and inflation consistently exceeds its 2% bogey. One should also keep in mind that as interest rates rise, the cost to the government of its borrowing escalates – so there is a built-in incentive to keep rates low.
In addition to rates impact on bond portfolios (bond prices fall as yields rise), a key implication of changing interest rates is on the discount rate used when calculating the value of future cash flows from stocks. Growth stocks are disproportionately impacted because more of their cash flow is expected further in the future. Therefore, the declining interest rates in 2020 that propelled growth stocks higher now take some air out of them as rates rise again. As a result, the yield curve’s control will be a highly watched discussion topic at the next FOMC, which ends this week on Wednesday, March 17. We will keep you informed as events unfold. In the meantime, as always, we recommend sticking to your investment policy and rebalancing as your portfolio requires it.