Posts Tagged ‘Operation Twist’
By Ben Berkowitz
Yahoo! News: Reuters
September 21, 2011
NEW YORK (Reuters) – The Federal Reserve’s latest move to stimulate credit for consumers and businesses, known as Operation Twist, is likely to threaten the earnings of some of the country’s largest insurers for years to come.
Wall Street in the past week has dimmed its view of MetLife, Prudential Financial and other big insurers, forecasting that they will have to cope with low rates and weak market returns through the end of 2011 and possibly well beyond.
The problem is that returns on insurers’ investment portfolios can’t keep pace with the obligations they have accumulated from torrid sales of annuities and life policies over the past few years.
“Ultimately I think it’s going to be a challenge to business models,” said Gregory Staples, co-head of U.S. fixed income portfolio management at Deutsche Insurance Asset Management, the world’s largest asset manager for insurers.
Insurers were demonstrating sound financial management in purchasing long-term bonds with the premiums they collected to balance their long-term obligations. But if the Fed’s Operation Twist is successfully executed it will push long-term rates lower and, according to some experts, force insurers to retrench on product sales.
No one is suggesting Twist will put insurers out of business, but it is exacerbating a problem that they have been contending with since the financial crisis of 2008.
Under Operation Twist, as announced Wednesday, the Federal Reserve sell shorter-term notes to buy longer-dates Treasuries. That will have the effect of keeping longer-term interest rates down, which the Fed hopes will spur consumers to borrow and spend.
“Folks have brought the low interest-rate environment up to No. 1 priority,” said Doug French, managing principal of the insurance and actuarial advisory practice at Ernst & Young. “We’re not going to get any relief from interest rates for the next two to three years.”
The accounting firm has modeled the investment return needs of the 25 largest life insurers over the next three years to determine what will happen if rates remain static or fall further.
“Their general account yields (in aggregate) are going to decrease by about 51 basis points over the next three years, and that’s a cumulative effect,” French said. “The life industry is under spread compression. It’s just going to continue, and, in fact, it’s going to get worse.
Annuities, a little understood but increasingly popular alternative for older Americans, are a paradoxical problem for insurers when rates plummet.
Limra, a marketing and research group for life insurers, estimates that 35 percent of U.S. retirees receive income from annuities. MetLife, the largest life insurer in the United States, reported that annuity sales rose 48 percent in this year’s second quarter.
Many of the products are sold with a guaranteed minimum benefit in return for an upfront payment. That means that regardless of the strength or weakness of the markets, the insurer has to write a check that doesn’t vary throughout the life of the product.
And that life is getting longer. Several insurers late last year warned that people were holding on to their annuities rather than cashing them out to invest in higher-return products. That creates a bigger nut for the insurers at a time when markets and the central bank aren’t cooperating.
“Once you get a little further out, there’s a very strong consensus that interest rates need to rise,” said JMP Securities analyst Matt Carletti. He and others said insurers are resigning themselves to anemic rates of return.
“Everybody expects a rise in interest rates but few expect it to happen any time soon,” Carletti said.
Rates on 10-year U.S. Treasuries prior to the Fed’s announcement were about 40 basis points below their previous 60-year low and almost two percentage points below their trailing five-year average, according to research from Oppenheimer.
Travelers Companies said earlier this month that 10 percent of its long-term fixed income investments mature annually through 2014 at an approximate yield of 5 percent. If Travelers reinvests that in Treasuries, the yield is likely to be two to three percentage points lower.
The prospect of anemic returns may be one reason why insurance shares have underperformed the broader market in six of the last seven months.
Shares were broadly lower after the Fed’s announcement.
Several insurers that were hoping for moderate interest-rate relief by now may consider higher-risk investment alternatives eventually, though not yet.
Deutsche IAM said some insurance clients have been seeking to invest in bank loans and other alternatives to traditional stocks and bonds if they could find yields higher than 3 percent, though their appetite has cooled.
“With the recent volatility in the marketplace and the recent sell-off and concern about risk there’s been a bit of a pullback in the interest in those asset classes,” Deutsche’s Staples said.
Most everyone agrees that insurers can sustain themselves during a prolonged period of low rates and meet their obligations through their cash flow rather than investment returns. But the question is what happens if rates do not rise in a few years.
“Let’s say, hypothetically, you’re in a low interest rate environment for the next five to 10 years, you’d have to say you’ve got to change your product mix, you’ve got to change what you’re selling,” Ernst & Young’s French said.
Read the entire article HERE.
by Tyler Durden
09/16/2011 14:51 -0400
As we have been pointing out since the beginning of the week, the one defining feature of the past 5 days has been a relentless short covering rally. And while the mechanics were obvious, one thing was missing: the reason. Well, courtesy of David Rosenberg’s latest, we may now know what it is. Bottom line: for all who think that Bernanke is about to serve just Operation Twist next week… you ain’t seen nothing yet. “The consensus view that the Fed is going to stop at ‘Operation Twist’ may be in for a surprise. It may end up doing much, much more.” Rosie continues: “Look, we are talking about the same man who, on October 2, 2003, delivered a speech titled Monetary Policy and the Stock Market: Some Empirical Results. I kid you not. This is someone who clearly sees the stock market as a transmission mechanism from Fed policy to the rest of the economy. In other words, if Bernanke wants to juice the stock market, then he must do something to surprise the market. ‘Operation Twist’ is already baked in, which means he has to do that and a lot more to generate the positive surprise he clearly desires (this is exactly what he did on August 9th with the mid-2013 on- hold commitment). It seems that Bernanke, if he wants the market to rally, is going to have to come out with a surprise next Wednesday.” In other words, stocks are now pricing in not just OT 2, and a reduction in the IOER, but also an LSAP of a few hundred billion. There is, however, naturally a flipside, to Bernanke’s priced in announcement: “If he doesn’t, then expect a big selloff.” In everything, mind you, stocks, bonds, and certainly precious metals. And, of course, vice versa.
Full note from Today’s Breakfast with Dave:
The consensus view that the Fed is going to stop at ‘Operation Twist’ may be in for a surprise. It may end up doing much, much more. And this may be one of the reasons why the stock market is starting to rally (a classic 50%+ retracement, which always occur after the first 20% down-leg in a cyclical bear market would imply a test of 1,250 on the S&P 500 at the very least). Hedge funds do not want to be short ahead of next week’s FOMC meeting, and who can blame them?
Here are 10 reasons why:
1) Just go back to August 9th. The Fed was supposed to make a more emphatic comment in the press statement about “extended period” as it pertained to the length of time the Fed would stay ultra-accommodative on the rates front. Bernanke went much further than anyone thought with his pledge to keep the funds rate at the floor at least to mid-2013.
2) Ben Bernanke has shown repeatedly that he is willing to take risks and be very aggressive.
3) Everyone knows that the Dow finished the August 9th session with a huge 430 point gain after the FOMC press statement was fully digested. Not only that, but when Bernanke held his two-day meeting in mid-December of 2008 and unveiled QE1, the Dow soared 360 points. And last November, the day after that two-day meeting when Bernanke made it clear in his Washington Post op-ed article how key it was to ignite the stock market, the Dow jumped 220 points. It may all be just for a near-term trade, but in an industry where every basis point counts, who wants to be short knowing all that?
4) At that August meeting, we know both from the statement and minutes that additional rounds of unconventional easing were discussed. And Mr. Bernanke made it very clear at Jackson Hole that they would be on the table again at the coming meeting
5) The Fed would like to be out of the picture during the election campaign (especially if Richard Perry ends up winning the GOP nomination).
6) The Fed has cut its GDP forecasts at each of the past three meetings.
7) The stock market is actually little changed from where it was at the last meeting and we know based on that Washington Post op-ed, that it is equity valuation (specifically the Russell 2000) that Ben wants to see rally. Sanctioning lower bond yields is just a means to that end.
8) There is no fiscal stimulus to bolster the economy, with the odds very high that the Obama jobs plan — some in his own party object to the package as per yesterday’s New York Times — will be dead-on-arrival on the House floor. The Fed is the only game in town.
9) Financial conditions have tightened nearly 100 basis points since the spring and deserve a policy response.
10) Bernanke announced at Jackson Hole that this coming meeting was going to be a two-day affair, not one day. The last time he did this was back in December 2008 and that was when he invoked QE1. There has to be a reason why it is two days, and it must be because he wants to build the case for three dissenters. The Board is being sequestered for a reason!
Look, we are talking about the same man who, on October 2, 2003, delivered a speech titled Monetary Policy and the Stock Market: Some Empirical Results. I kid you not. This is someone who clearly sees the stock market as a transmission mechanism from Fed policy to the rest of the economy. Here is a key excerpt from that sermon:
“Normally, the FOMC, the monetary policymaking arm of the Federal Reserve, announces its interest rate decisions at around 2:15 p.m. following each of its eight regularly scheduled meetings each year. An air of expectation reigns in financial markets in the few minutes before to the announcement. If you happen to have access to a monitor that tracks key market indexes, at 2:15 p.m. on an announcement day you can watch those indexes quiver as if trying to digest the information in the rate decision and the FOMC’s accompanying statement of explanation. Then the black line representing each market index moves quickly up or down, and the markets have priced the FOMC action into the aggregate values of U.S. equities, bonds, and other assets.
Even the casual observer can have no doubt, then, that FOMC decisions move asset prices, including equity prices. Estimating the size and duration of these effects, however, is not so straightforward. Because traders in equity markets, as in most other financial markets, are generally highly informed and sophisticated. any policy decision that is largely anticipated will already be factored into stock prices and will elicit little reaction when announced. To measure the effects of monetary policy changes on the stock market, then, we need to have a measure of the portion of a given change in monetary policy that the market had not already anticipated before the FOMC’s formal announcement [emphasis added].”
In other words, if Bernanke wants to juice the stock market, then he must do something to surprise the market. ‘Operation Twist’ is already baked in, which means he has to do that and a lot more to generate the positive surprise he clearly desires (this is exactly what he did on August 9th with the mid-2013 on- hold commitment). It seems that Bernanke, if he wants the market to rally, is going to have to come out with a surprise next Wednesday. If he doesn’t, then expect a big selloff.
What he is likely to do is another story, but here are some options:
1) Expand the balance sheet further and simply buy more bonds (at the longer end of the curve).
2) Eliminate the interest paid to commercial banks on excess reserves (to try to spur lending).
3) Announce an explicit ceiling on the 10-year note yield (say 1.5%), which the Fed has done in the distant past. Based on Bernanke’s prior rhetoric, this would seem to be a preferred strategy (though the Fed relinquishes control of the balance sheet).
4) Buy foreign securities (bail out Europe and weaken the U.S. dollar — talk about killing two birds with one policy stone).
5) Announce an explicit higher inflation target or perhaps a lower unemployment rate target (i.e. reinforce the DUAL mandate).
6) As Mr. Bernanke stated for the record in November 2002, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. It could offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector.
Read the entire article HERE.