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Fed Does the 'Twist' to Boost Economy

NEW YORK ( TheStreet) -- The Federal Reserve announced it will enact "Operation Twist," selling short-term securities to buy $400 billion in long-term Treasuries to support the economy.

The decision, which was delivered at the conclusion of the Federal Open Market Committee's September meeting, caused stocks to drop despite the fact that a maturity extension was overwhelmingly expected by the market. The strategy, otherwise known as "Operation Twist," involves selling some short-term securities to buy more long-term assets, thereby lowering long-term interest rates without further expanding the Fed's portfolio.

"This is Operation Twist with a twist," said Erik Davidson, deputy chief investment officer for Wells Fargo Private Bank. "It's probably more aggressive than what the market was expecting. The announcement came out late, but so far, stocks look spooked."

By the end of June 2012, the Committee will buy $400 billion of Treasury securities with remaining maturities of 6 to 30 years and sell an equal amount of Treasuries with remaining maturities of 3 years or less.

Federal Reserve Chairman Ben Bernanke

The market has been anticipating additional easing measures from the Fed since Chairman Ben Bernanke announced that the FOMC's September meeting would be extended by a day to allow for a "fuller discussion" of the range of tools it has as its disposal. Bernanke had also previously indicated that the central bank is prepared to use these tools in order to stabilize the recovery.

The Fed said it would extend the maturity of its holdings in order to "support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate."

The FOMC also said it will reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities into agency mortgage-backed securities to help boost mortgage markets. The Committee will also continue to roll over maturing Treasury securities at auction.

"The Fed is really doing everything that they can do, but at some point they're just going to run out of tools," Davidson said. "With Operation Twist they're providing both the carrot and the stick by making it so miserable to not borrow that they're forcing investors our there. Investors should get out of bonds and pick up all the attractively-priced assets such as stocks ... There's so much uncertainty and investors crave certainty. When they don't have it, they price it in, and that's what brings down valuations."

Committee members Richard Fisher, Narayana Kocherlakota and Charles Plosser voted against the additional easing measures.

As expected, Committee members voted to keep key interest rates unchanged at zero to 0.25% and repeated their intention to keep rates exceptionally low at least through mid-2013.

Minutes from the FOMC's September meeting will be released on Oct. 12. The Committee's next meeting will be held Nov. 1-2.

-- Written by Melinda Peer in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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