Why were US equity markets down heavily after Fed's Operation Twist announcement?

The US Federal Reserve (“the Fed”) announced the employment of Operation Twist today following 2 days of meetings.  So what is Operation Twist?  In plain English – the Fed is selling out of some of its short dated bonds and buying longer dated securities.  The last time this was enacted was in 1961.

The Fed is aiming to keep interest rates in long dated securities low in an attempt to stimulate the economy. By long dated securities we are talking anything with a maturity in excess of 5 years. 

With the Fed trying to stimulate the economy why did equity markets perform so poorly today after what could be conceived as positive news?

There are many convoluted and complicated answers one could give to why markets fell sharply in the last hour of trading. The following points I trust provide investors with a simple explanation.

     

     1)   The Fed used language such as "significant downside risks" and identified fears about the volatility in global markets.  This sort of language spooks investors.

     

     2)  The Fed concentrated more on purchasing 30 year treasury securities as opposed to the 7 year & 10 year securities the market was expecting.  This maturity range is generally seen as a sweet spot for businesses.  The market does not like surprises and investors reacted accordingly. 

                                                                                                                  

     3)  As a colleague of mine (Alan Goldman of Goldman Henry) points out, the move by the Fed to focus more on the longer dated bonds is forcing pension funds and other large institutions to rebalance their portfolios to ensure they remain within their investment mandate guidelines. The only way these investors can achieve this rebalancing is to sell equities and top up their holdings in bonds.  By applying the laws of economics when there are more sellers than buyers the price of a commodity or asset falls.

Ratings agency Moody’s added further fuel to the fire when they downgraded Citigroup, Bank of America and Wells Fargo on the basis they did not believe the US government would bail them out if they failed. 

There is a belief amongst some commentators that not all the information has been completely digested.  The traders may be right in saying today’s sell off was nothing more than a knee-jerk reaction.  Time will tell.