Thoughts on the Fed’s Twist

Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.

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The Twist in essence reduces to a bank subsidy. How?

1) Banks are taken out of levered long duration Treasury paper at cycle lows
2) Banks increase their net holdings in the short end on a levered, positive carry basis (by repo-ing purchases of short paper with the Fed)

Is the Fed’s solvency at any lesser or greater risk? NO.

1) Despite the duration extension of the Fed’s balance sheet, there is no incremental risk
2) The Fed must now, however, be THE BID for the long end
3) Real risk to bondholders, regardless of duration, is dollar devaluation (real risk), not rising interest rates (nominal risk)

So, in the near term, banks win, Fed breaks even, dollar and unlevered bondholders risk of devaluation is escalated.

Where from here?

1) Incremental QE is no more or no less needed as a result of The Twist
2) Incremental QE is ABSOLUTELY still necessary to shrink the unreserved debt to base money stock ratio
3) Future QE may very likely require the Fed to bid out through the long end to defend yields across its holdings maturity spectrum

In sum, this is a move to help recapitalize banks under the guise of supporting the housing market and any wealth effect that might flow from that outcome. This is all about the banks income statements. Future and imminent QE will be about their balance sheets (dollar devaluation which then boosts nominal asset/collateral pricing).

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Lee Quaintance & Paul Brodsky
QB Asset Management Company, LLC
pbrodsky-at-qbamco.com

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