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Federal Reserve's Operation Twist drives Canadian dollar below par, hits stocks

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Operation Twist disappoints With its benchmark interest rate effectively at zero and its ammunition running out, the Federal Reserve today unveiled what has been dubbed "Operation Twist," a $400-billion (U.S.) program aimed at narrowing the gap between short- and long-term yields to help boost spending and juice the stalling recovery.

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The central bank said in one of its most eagerly awaited statements that recent evidence indicates a still-wretched jobs market, ever so slow increases in household spending, and a depressed housing market. It was particularly glum on the outlook for the millions of Americans without jobs, and it's clear why the Fed is so concerned.

"The committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the committee judges to be consistent with its dual mandate," the central bank's policy-setting panel, the Federal Open Market Committee, said in a statement.

"Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets."

The Fed left investors spooked by the grim outlook. Treasury yields fell, yes, as did the Dow Jones industrial average , the S&P 500 and Toronto's S&P/TSX composite .

The U.S. dollar climbed, and the Canadian dollar sank below parity, closing at 99.41 cents for the first close below the U.S. dollar since the beginning of February.

"We had quite a violent reaction to the FOMC announcement, Operation Twist," said senior currency strategist Camilla Sutton of Scotia Capital, noting that other currencies fared far worse.

The Fed will sell $400-billion of Treasuries that mature in three years or less, and buy the same amount with maturities of six to 30 years, by the end of next June. This so-called twist was a measure last used in the 1960s and is so called because its aim would be to "twist" interest rates and narrow the gap between short- and long-term bonds, selling the shorter and buying the longer, and hopefully stimulating borrowing.

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"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the Fed said.

The central bank also moved to hold down mortgage rates, announcing it will reinvest what it gets from maturing agency debt and mortgage-backed securities back into mortgage debt.

Three members of the panel didn't agree with the decision, the central bank said. They're worried about stoking inflation.

The Fed rightly ignored the calls of some senior Republicans to stop trying to fiddle with the economy - God only knows what they were thinking - though several analysts question how successful the Fed will be. Here are some of their views:

"Monetary policy is reaching its limits and we believe that the effect of the steps announced today on both the economy and markets will be modest, at most. Long-term rates are already low and have likely already discounted, at least in part, the twist action. The latest move is also unlikely to have the same positive impact on exports via the cheaper dollar that [the second round of quantitative easing]did." Peter Buchanan, CIBC World Markets

"The Federal Reserve is keen on doing all it can to promote growth, but there is very little they can do to alter the economic outlook at this point. On the margin, 'operation twist' may lead to slightly lower interest rates and therefore slightly higher demand for credit. Moreover, as markets had largely already priced in this action, a failure to do so would have caused a backup in yields, which could be deemed counterproductive. Nevertheless, with the housing market still sinking under the weight of the foreclosure crisis, lower interest rates are unlikely to spur credit demand in a meaningful way." James Marple, Toronto-Dominion Bank

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"The big question is whether this latest action will accomplish anything? We doubt it. Judging by the modest rally in 10-year Treasury yields since the announcement most of this was already priced in. More generally, the cost of borrowing simply isn't the problem. Businesses don't have the confidence to invest and half of all mortgage borrowers don't have the home equity needed to refinance at lower rates." Paul Ashworth, Capital Economics

"We expect the Fed's actions to have very little visible effect on the economy, because the level of interest rates and the shape of the curve are not the key constraints on growth. Mr. Bernanke wants to be seen to be doing something, but his hand is not on the fiscal policy lever." Ian Shepherdson, High Frequency Economics

"While lower longer-term interest rates of all stripes should provide at least some incremental support to the economy, the Fed appears to want lower 30-year mortgage rates the most, in order to stimulate the housing sector ... The Fed still faces a Catch-22 (interestingly, the seminal novel was first published in 1961, about the same time Chubby Checker was twisting again): While housing can surely help jobs, housing won't stabilize until job growth improves … no matter how low mortgage rates are. The only thing we can do is hope, and wait. If nothing seems to be happening on either the job or housing fronts, look for the Fed to ease further." Michael Gregory, BMO Nesbitt Burns

"Although we would have liked to also see a reduction in the interest rate paid on excess reserves held by commercial banks (there is whopping $1.5-trillion sitting at the Fed), it may have been difficult to go that far at this time given the amount of dissention among the FOMC voting members. How far the current policy will take us remains unknown as the Fed is trying to buy some time while Congress continues to dither about the fiscal outlook. The FOMC still has some options left to fight another day but its arsenal has been severely reduced. Mr. Bernanke is certainly providing an environment that is conducive to growth but its traction is impeded by fiscal uncertainty." Paul-André Pinsonnault, National Bank of Canada

(As The Globe and Mail's Kevin Carmichael noted in his look at Operation Twist earlier this week, the sounds of Chubby Checker's 1960s classic Let's Twist Again have been prominent in the run-up to today's decision. For the younger set, the Twist - it's a rock 'n' roll dance - became something of a craze in the early '60s, with many songs to go along with it.)

New rules for broadcasters Canada's broadcast regulator today unveiled new rules to deal with potential conflicts introduced by "vertical integration," the industry term for the companies that bring you your cable or satellite package buying up more of the channels they beam into your home.

Included in the announcement is a new code of conduct for integrated companies such as Shaw Communications Inc., Rogers Communications Inc., Quebecor Inc. and BCE Inc., with rules requiring them to carry a minimum amount of independently owned channels, and to prevent them from using their market power to negotiate unduly harsh terms for their own channels on competing services, The Globe and Mail's Susan Krashinsky reports.

Inflation runs hotter Inflation in Canada is running at a faster pace than expected.

Consumer prices climbed 0.3 per cent in August, according to Statistics Canada today, bringing the overall annual rate to 3.1 per cent. That's faster than July's 2.7 per cent and on par with June's 3.1 per cent.

Even the core rate, which excludes volatile items and guides the Bank of Canada, was higher than expected, coming in at 1.9 per cent and up from 1.6 per cent in July. That underlying inflation was pushed up by increases in car insurance premiums, food prices at restaurants and higher costs for bakery goods and cereal.

The overall annual rate was again driven by prices for food and costs at the gas pump.

How much of a difference will this make to the Bank of Canada? It's certainly faster than the central bank would like, but Governor Mark Carney has more important things on his mind at this point, given the slowing U.S. economy, the European debt crisis, and the tremendous uncertainty in global markets.

"Despite the upside surprise to core inflation, the Bank of Canada appears in no rush to tighten given the economic and financial market headwinds that are currently blowing," said Robert Kavcic of BMO Nesbitt Burns.

Having said that, noted Emanuella Enenajor of CIBC World Markets, today's reading "reduces the odds" that the central bank will cut rates in the near term.

HP shares jump on report Shares of Hewlett-Packard Co. jumped today on reports that the company is considering bringing in Meg Whitman, the former chief of eBay, as its new CEO. She would replace Léo Apotheker - he hasn't gone but the suggestion is that he soon could be.

Ms. Whitman sits on the HP board.

Steps for RIM RBC Dominion Securities has cut its price target on shares of Research In Motion Ltd. after last week's quarterly results, advising the BlackBerry maker there are four key issues it needs to solve before investors "properly" value the company.

"We view recent Q2 results as symptomatic of RIM's failure to address these challenges, which are: 1) backwards-looking, uncompetitive products and software; 2) marketing and launch execution; 3) investor credibility/visibility; and 4) governance," said analysts Mike Abramsky and Paul Treiber.

Here's what they want to to see, according to their research note:

  • Competitive products and software
  • Better execution
  • Better financial results

At this point, RBC expects earnings per share of $4.95 (U.S.) in fiscal 2012 and $5 the following year.

RIM was hit hard after it released second-quarter results showing a plunge in profit and revenue. While the release of new smart phones with an upgraded operating system appeared to get off to a strong start, it only came in the last few weeks of the quarter, which didn't help results but could point to better times ahead.

The company is in an increasingly competitive battle with Apple Inc. , whose new iPhone 5 is reportedly coming in early October, and Google Inc. , whose Android system has become hugely popular.

Greece cuts deeper Greece is slashing pensions, extending a tax hike on properting and giving 30,000 public sector workers a year to find new jobs, according to reports.

The measures are part of a deeper austerity package meant to help secure a further €8-billion in rescue money in talks with the European Union, European Central Bank and International Monetary Fund.

The Greek government has an interesting, and much more humane, program than other countries. The public servants affected are put in what's known as a "labour reserve." They'll get just 60 per cent of their normal pay but they'll have 12 months to find other jobs. With unemployment running so high, though, it's not clear whether they'll meet with success.

The measures come after what all involved say was progress in two days of talks between the government and its bailout friends.

But could it be that the optimism is misguided? They talked for two days, and said they would continue next week, all aimed at meeting commitments for Greece to get a further €8-billion in rescue money. If everything is on track, why not send a more confident message to markets that are hanging on every word?

"The statement by the EU that 'good progress' is being made, while obviously designed to inspire confidence, doesn't really do anything of the sort, and does suggest that significant differences remain," said CMC Markets analyst Michael Hewson.

"If the last few days are anything to go by this continued game of political brinksmanship looks likely to continue all the way into October, when Greece will eventually need the money to avoid a default."

It's Downgrade Day It was hard keeping track of all the credit downgrades today, this time on the corporate side.

Moody's cut the ratings on three big U.S. banks, Bank of America Corp. , Wells Fargo & Co. , and Citigroup Inc. , suggesting Washington won't be as likely to support an ailing bank as the last time around.

Separately, S&P downgraded seven Italian banks.

Japan's exports rise Japan's economy continues to recover from the devastating earthquake and tsunami that ravaged the country in mid-March.

Japanese exports climbed in August by 2.8 per cent, the government said today, marking the first increase in six months and a clear sign that manufacturers are rebounding from the crisis that led to some shortages. Imports surged more than 19 per cent, for a trade deficit of ¥775-billion, which BMO Nesbitt Burns noted is an ¥800-billion "deterioration from last year.

While the economy is recovering, Japan's exporters are still hampered by a strong yen.

"The strong yen is clearly weighing on Japan's recovery and could limit the anticipated second half rebound in GDP growth," said BMO's Benjamin Reitzes.

In International Business Brewing giant SABMiller PLC agreed to buy Foster's Group Ltd. today for an increased price of $5.10 (Australian) per share valuing the Australian beer maker at $9.9-billion ($10.2-billion U.S.) to give SABMiller a leading position in the Australian beer market. David Jones of Reuters reports from London.

In Economy Lab In Canada's early years, prosperity was primarily determined by European demand for its natural resources. In the 20th century, the U.S. became the key market. Now it may be Asia's turn, Stephen Gordon writes.

In Globe Careers Having volunteer work on your résumé has the potential to make you more attractive to employers, a new survey suggests. The Globe and Mail's Wallace Immen reports.

From today's Report on Business

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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