As generally anticipated the FED on Wednesday expanded its operation twist, which would have expired by end of June. The twist is now expected to end at the end of the year. In principle, that development is expected to trigger the sale of near-term securities and purchase of long-term bonds. Alan Ruskin, the head of G10 FX strategy at Deutsche Bank, summarizes a couple of implications of the Twist on FX, Gold and rates.
The long-term rates for the Twist are being associated with a sturdier USD against other major currencies. It is also being associated with lower commodity prices especially for the oil. The twist is also expected to cause decline in bond, equity, FX volatility. It is somewhat difficult to clarify the causality in this instance, since crisis in Europe rather than the Twist could have served as the main driver of the dollar, while the situation in China and the dollar have had a major influence on the commodity prices.
The EUR/USD pair has been tracking the ECB’s balance sheet more closely that the Federal Reserve’s balance sheet in line with the significance of the situation in Europe. The pair has been showing a significant weakness which is related to the actions of the ECB’s balance sheet. This weakness began from the last LTRO, perhaps since the spikes of LTRO liquidity were abnormally large. Nevertheless, there are threats that the current RUT fault has priced in considerable ECB balance sheet growth.
Even though Twist is associated with considerably high price increase estimations such as QE1 and QE2, nominal long-term yields have dropped. This comes as a result of a drop in real yield, more than what was predicted. Consequently, gold has declined, which signifies little fear over larger price increase implications of unorthodox operations- again due to lack of expansion of the Fed’s balance sheet.
The operation Twist is also being associated with lower long-end rates. The flat yield curve that is relative to the strength of the dollar is also being attributed to the Twist.