With this, Fed will buy $400 billion of long-term treasury bonds, maturities with 6-30 years and sell an equal amount of short-term treasury bonds, maturities with 3 years or less by June next year, the move that roll the markets upside-down.
What made Dollar started looking greener as against all major currencies?
Right after Fed announced its policy measures and warned the U.S. economy is facing a serious downward risk, there arose a sudden rush of market risk aversion. The dollar index rose against rupee and all major currencies across the board to a seven-month high, check out why?
No Quantitative Easing: Fed's last quantitative easing of $600 billion hasn't had any stimulative effect on the economy but on the flip side, the real inflation went up. An increase in money supply has an inflationary effect, so Fed announced no quantitative easing this time i.e. Fed will not print any new money. The situation of shortage made investors feel – the dollar is still the safe haven currency, supporting the dollar surged.
Balance-sheet re-balancing: To flatten the yield curve i.e. similar yields to all maturity bonds, Fed decided to re-balance its $2.3 trillion balance-sheet by replacing more of long-term debt with that of short-term debt. The plan could lower rates for mortgages as well as those for consumer and business loans by putting more downward pressure on long-term interest rates, the aid to the beaten-up housing sector.
Investors began buying back dollars following the announcement because they are now expecting a prolonged period of slower global growth. Investors consider the U.S. currency to be a safe-haven currency, and they tend to buy it in times of global economic turmoil.
With interest rates near zero and long-term treasury notes turning sour, short-term bonds seems to be an only attractive option so investors heaped into the greenback, lured by the charm of short-term rates on U.S. bonds, which again pushed up the dollar against major other currencies.
The Federal Open Market Committee (FOMC) action known as Operation Twist last happened 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. While, in Quantitative Easing, the dollar has a counter effect, it usually fall against major currencies due to increase in money supply.