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Fed twists again - bane for savers, borrowers' boon
July 3, 2012 / 4:02 PM / 5 years ago

Fed twists again - bane for savers, borrowers' boon

NEW YORK (Reuters) - With bond yields and mortgage rates already at historic lows, the Federal Reserve’s move to prolong the shelf life of Operation Twist is unlikely to do much to lower U.S. interest rates.

Still, under the status quo, borrowers, including Uncle Sam, should continue to enjoy cheap loans, while savers -- especially older Americans living on a fixed income -- will suffer longer from meager interest income.

“Savers are hurting and borrowers are benefiting,” Michelle Meyer, senior economist at Bank of America Merrill Lynch in New York said of Operation Twist.

Tuesday marked the beginning of the second leg of Operation Twist that involves the Fed’s purchases of long-dated Treasuries with proceeds from the sales of its short-dated government debt.

The first program expired at the end of last week. Here’s a breakdown of the winners and losers from the second iteration of “Twist”:

SAVERS, BANKS GET PINCHED

While short-term interest rates have ticked up slightly this year, interest rates on bank accounts and money market funds have not budged. Those funds are still paying rates barely above zero, not even keeping up with inflation, which was running at a 1.7 percent annual clip in May.

The rise in short-term rates has boosted borrowing costs for banks, while interest income on their bonds and other investments has fallen.

Those short-term borrowing costs have risen under Operation Twist because there is more supply of short-dated Treasuries in the open market. Some are being held by Wall Street banks, driving up the demand to fund the debt until the banks could re-sell them to investors.

Banks and Wall Street firms raise cash in the short-term funding market and, in turn, make loans or take positions in longer-dated, higher-returning investments.

“This flatter yield curve is marginally worse for banks,” Bank of America’s Meyer said.

Banks’ net interest margin -- what they earn on their loans and securities and what they pay on deposits and other borrowings -- have been pinched in this low-rate climate.

JPMorgan Chase, for example, said its first-quarter interest margin shrank to 2.61 percent from 2.70 percent in fourth quarter and from 2.89 percent in same quarter a year earlier.

Money funds, while they have been charging banks more for loans and to buy their securities, have not yet passed on their uptick in interest income to investors. The funds have been absorbing various operation costs after the Fed dropped short-term rates near zero more than three years ago.

LOW RATES FOR BORROWERS

On the other hand, with this Fed program keeping mortgage rates at rock-bottom levels, it makes it easier for qualified borrowers to afford to buy a home, and existing homeowners can refinance into lower-cost loans to lower their monthly payments.

The interest rates on 30-year mortgages, the most widely held home loan in the United States, averaged a record low of 3.89 percent in the latest week, according to Bankrate.com.

Until the Fed decides to pursue another round of large-scale bond purchases, a further decline in U.S. borrowing costs will hinge on investors’ safe-haven purchases of Treasuries, demand that is fueled by anxiety about a slowing global economy and the fiscal woes in Europe.

“The extension of Operation Twist is nothing more than a symbolic gesture,” said Greg McBride, senior financial analyst at Bankrate.com in North Palm Beach, Florida. “The overall concerns about the economy and the euro zone debt crisis are still the main catalysts behind the movements in rates.”

This bond program, which began last October, was initially scheduled to end on Friday before the Fed extended it into year-end. The Fed already bought $400 billion in long-dated bonds and projected it will buy another $267 billion.

Editing by Padraic Cassidy

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