Under the Maturity Extension Program (MEP), popularly referred to as “Operation Twist,” the Federal Reserve Bank of New York (FRBNY) sells Treasury issues maturing within three years. The MEP period has been marked by low and stable inflation and interest rate expectations, increases in Primary Dealers inventories of bills and notes, and a series of announcements from the Federal Open Market Committee (FOMC) that further support low interest rate expectations.
Our Objective is to learn
-1- What the buildup of auctioned short end Treasuries at Primary Dealers says about market saturation and dealer treatment of the securities.
-2- To what extent an MEP auction facilitates liquidity enhancement.
-3- What FOMC accommodative policy announcements have done to patterns of yields and bids.
Our Priors are :
-a- Bids targeting value describe a well functioning market
-b- Bids creating anomalies may signal either saturation or a lack of strategic behavior, depending on how wide spread they are.
-c- Accepted bids manifesting in anomalies would suggest that FRBNY can improve allocation, when better alternatives exist.
Data/Methods
The first two questions employ an event study format. We consider yield curve anomalies ahead of announcement, following announcement as implied by the range of bids, {high, low, average}, and following settlement. Here the general dependent variable is an asymmetric “butterfly,” or “sandwich” estimator over proximate maturities, of the type described in Seligman (2006).
Given the literature on segmentation, Duffie (1996), Keane (1996) and Longstaff (2004) for example, concerning the liquidity of ‘on-the-run’ (new) issues we consider how an MEP auction compares to a reopening by Treasury in terms of liquidity enhancement.
The third question, on FOMC announcement effects, takes advantage of the policy announcement timing. The MEP is broken into two periods of commitment by the Federal Reserve to maintain low rates: through mid-2013 prior to January 25, 2012 and through the end of 2014 thereafter.
Here we employ a difference in differences estimator that considers the deviation in differences as follow:
Pre 9/22 9/22 – 1/25 Post 1/25
Maturities prior to mid-2013
Maturities from mid-2013 to end-2014
Maturities later than 2014
Our data are high frequency matched prices over the full MEP, enhanced by institutional data.
Expected Results
We expect to be able to address our priors in ways that contribute to to monetary policy and portfolio dynamics between central banks and open markets. We will document the impact of the program on Primary Dealer asset holdings, bidding behavior and the liquidity of issues at market. Finally we will document the direct impact of accommodative announcements for bid differentials between pre- and post- accommodative regimes, as fit the objectives outlined above.