Nothing for CRE in Operation Twist

By Dr. Sam Chandan

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Markets were unimpressed by the Federal Open Market Committee’s announcement last week that it would move forward with its Maturity Extension Program and Reinvestment Policy. More commonly cited as Operation Twist in reference to a similar program undertaken 50 years ago, this latest monetary policy intervention will see the Fed sell $400 billion in shorter duration securities between now and next June. Over the same period, the Fed will purchase an equivalent dollar volume of securities with six to thirty-year maturities. The goal of this rebalancing is to push longer-term rates lower, supporting more accommodative financial conditions than can be achieved through the Fed Funds target alone. Whether Operation Twist will achieve its goal, and whether it matters for the economic outlook, are questions for debate.

Will the program push long-term rates lower? At the market’s close last Friday, the yield on ten-year treasuries was already at a historic low of 1.81 percent. Based on current measures of inflation, the real rate is already negative. It is not clear if investors will tolerate a further erosion of yields at prevailing levels of issuance. One benchmark, economists have invested considerable effort in quantifying the impact of the 1961 foray into maturity rebalancing. In a recent research brief from the San Francisco Fed, economists from the Twelfth District estimate that the program pushed rates only 15 basis points lower. Of course, financial markets have evolved significantly since that time. Accounting for some of that evoluation and given that current rates are already at such extraordinarily low levels, our models show an average impact of 8 to 12 basis points, all things being equal, between now and the program’s conclusion in June 2012.

Will marginally lower rates make a difference? While low baseline rates are certainly to the advantage of borrowers, they are not a sufficient condition to unleash investment or drive an expansion of payrolls. Given the opportunity to expand capacity, firms are choosing to hoard cash resources, even though rates are already negative in real terms; the binding constraints on firms’ decisions relate to the outlook for demand and business confidence, not a need for rates to fall just slightly lower. It is a serious error – one that has already been made in policies designed to support housing markets – to think that low costs of capital will foment robust outcomes if other conditions in the real economy preclude households’ and firms’ accessing long-term financing.

In sum, commercial real estate investors and lenders can be forgiven for a skeptical view of the latest Fed action. Long-term rates are not low because of monetary policy. Rather, they are low because of global financial instability and a frustratingly weak outlook for domestic growth. While that has allowed cap rates to decline – to a worrying degree in some markets – even while risk spreads remain elevated, the Fed’s action is unlikely to have a measurable impact in offsetting any of the real economy’s challenges.

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