By Isobel Kennedy and Joseph Plocek

NEW YORK, Dec 6 (MNI) – While the markets await the important jobs report
Friday, analysts were fine tuning their calls for next week’s Federal Reserve
meeting.

The bond market’s main concern is what will be done about the expiring
Maturity Extension Program — also known as “Operation Twist” — in which the
Fed was selling about $37 billion short-dated Treasuries each month and buying
about $45 billion longer-dated Treasuries each month.

To be clear, taken together with the Fed’s monthly buying of $40 billion
agency mortgage-backed securities, the Fed was buying about $85 billion in
assets each month.

Since Operation Twist expires at the end of December, analysts have been
trying to figure out what the Fed is going to do. Everyone knows the Fed is
going to keep buying Treasuries but the question is how mmuch they will buy each
month. No one expects any Fed selling to offset these new purchases.

Some analysts have done fancy calculations about how many Treasuriess the
Fed needs to buy to duplicate the simulative effect of Operation Twist. We all
know that the Fed would not dream of doing anything that smacked of tightening!

But the analysts at Wrightson ICAP kept it very plain and simple in their
Fed call.

“When the Fed first introduced its open-ended MBS purchases in September,
it made a point of referring to its aggregate monthly purchases of ‘$85 billion’
at the long end, consisting of $40 billion of net MBS purchases (in addition to
any monthly reinvestments) and $45 billion of Treasury purchases in maturities
of six years or longer,” Wrightson says.

“Chairman Bernanke and his colleagues have repeated the $85 billion number
often enough since then to establish it as the default presumption for the
monthly pace of purchases in the first quarter.”

Wrightson say economic conditions have not changed enough since September
to warrant a major adjustment “and a minor tweak would just create uncertainty
about whether (and how) the Fed planned to fine-tune its operations from meeting
to meeting in the future.”

We asked a few economists about why everyone is so much on board for about
another $85 billion Fed buying program when that is the gross amount being done
currently, not the $48 billion when you net out the $37 billion in Operation
Twist sales each month.

The general opinion about the Fed’s strategy is “damn the torpedoes, full
speed ahead.”

One economist pointed out that each stimulus seems to have less effect, so
a little more adding than is occurring now will probably have the same rate
effect.

Another suggestion was that the Fed may not be as worried about duration as
the Street is — in other words, the Fed’s intent may not be to just match the
duration in MEP. The Fed therefore could target buying less in over-7-year
maturities than currently if they were worried about too much stimulus.

Another economist said additional reserves should drive the effective funds
rate lower “but because there seems to be a non-linear relation between
reserves” and funds could ‘only’ go down to around 10 bps by year-end 2013.

Rational explanations aside, let’s face the fact that the major central
banks around the world are no longer operating like central banks. They no
longer have that luxury, really.

And the Fed is a prime example. By the end of December, the Fed will have
amassed almost $1 trillion in agency MBS. It already has no Treasury bills and,
while it holds $1.6 trillion in Treasury notes and bonds, none are due in less
than 3-years.

Future textbooks will reflect the ravages of the financial crisis that
began late in 2007 and are still being felt today.

On the economic calendar Thursday, initial jobless claims fell 25,000 to
370,000 in December 1 week, lower than the 375,000 expected and following a
slight upward revision to the previous week.

For the jobs report tomorrow, the MNI consensus is fro a rise of 95,000
jobs.

NOTE: Talk From the Trenches is a daily compendium of chatter from Treasury
trading rooms, as well as some sister market trading rooms, and is offered as a
gauge of the mood the financial markets. It is not necessarily hard, verified
news.

–MNI New York Bureau; tel: +1 212-669-6434; email: ikennedy@mni-news.com

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