After Twist, What Is the Fed's Next Move? TIME is running out for Operation Twist, the Federal Reserve stimulus program named for that hip-swiveling dance from the 1960s. The Fed's twist is scheduled to end soon, mainly because the central bank is running low on the short-term securities that keep the action going. Decorum may prevent it from adopting "Gangnam Style" moves right now, but the Fed's mesmerizing dance with the bond market isn't over yet. "The bond market is counting on the Fed - and can keep counting on it - to hold short-term interest rates near zero for some time to come," said Kathy A. Jones, fixed-income strategist for the Schwab Center for Financial Research. And with the weak economy vulnerable to a shock if the Congress and White House don't reach an agreement soon on fiscal policy, the Fed is likely to introduce further innovations, perhaps as early as this week. The Fed's hypnotizing moves have captivated the bond market for many months, said Ed Yardeni, an independent economist. The stock market still reacts to news events these days; the bond market barely does. The Fed has put it in a nearly perpetual rally. That can't last forever, but ultralow yields and remarkably rich prices have persisted largely because of the Fed's daring experiments and interventions. When Operation Twist arrived in September 2011, it was a retro maneuver with a Kennedy pedigree. In February 1961, the country was in recession and unemployment was high (though it was only 6.8 percent, compared with 7.7 percent today and 9.1 percent in September 2011). President John F. Kennedy declared that he would stimulate the economy with a joint Fed-Treasury operation first called Operation Nudge, because it involved nudging interest rates by altering the composition of the Fed's portfolio. That name didn't catch on. Instead, traders called it Operation Twist in homage to the dance popularized by Chubby Checker. Twisting describes some of what the Fed has been doing in recent months, as well as back in 1961: shifting the duration of its portfolio by selling short-term securities and buying longer-term ones. Because bond prices and yields move in opposite directions, large purchases of longer-term securities can be expected to drive up those prices and lower those longer-term interest rates. Despite the Fed's bulk sales, current short-term rates have remained low, largely because the Fed exercises considerable influence over those rates. The twist appears to be winding down, though, because "the Fed has replaced $667 billion in short-term Treasuries on its balance sheet with an equivalent amount in longer-term Treasures" since September 2011, according to "A Citizen's Guide to Unconventional Monetary Policy," a report by the Federal Reserve Bank of Richmond. Capital Economics, a research firm, said in a separate report that the Fed "doesn't have any more short-term Treasury securities to sell, at least not with maturities of less than three years." Many market strategists assume that the Fed will shift to outright purchases of Treasury securities without selling shorter-term securities from its portfolio, expanding its already swollen balance sheet. It ballooned from $869 billion in August 2007 to "well over $2 trillion," according to the Fed's Web site. Since 2008, the Fed has engaged in three rounds of unconventional large-scale asset purchases, known as quantitative easing. In the first round, QE1, from November 2008 to March 2010, it bought $1.75 trillion in long-term Treasuries and other securities, the Richmond Fed said. In QE2, from November 2010 through June 2011, it bought $600 billion in long-term Treasuries. QE3 has been under way since September 2012, with the Fed buying $40 billion each month in mortgage-backed securities. Now, said Ned Davis Research in a report last week, the Fed is likely to replace Operation Twist with purchases of Treasuries, perhaps in the $45 billion a month range, bringing its total monthly purchases to $85 billion. Similarly, Jim McDonald, Northern Trust's chief investment strategist, said: "With the problems the economy's been facing - and with the prospect of a fiscal cliff in Washington - we expect the Fed to err on the side of accommodation, and convert Operation Twist into full-bore quantitative easing." As Senator Everett McKinley Dirksen is reputed to have said, "A billion here, a billion there, and pretty soon you're talking real money." RECENT speeches by Fed officials reveal that they are considering an additional option - engaging in more explicit "forward guidance" about their intentions, linking their policy on interest rates to metrics like the unemployment and inflation rates. "This is all about signaling," Ms. Jones said - about using language and numbers to persuade investors, consumers and people in business that money will be cheap and plentiful for a long time to come. During the worst phase of the financial crisis, the Fed's extraordinarily expansive monetary policy was intended to prevent the economy from plunging into a possible depression. These days, it is intended to help restore vigor to the economy, with mixed results so far. The November survey of Blue Chip Economic Indicators, for example, showed that economic forecasters expected gross domestic product growth of only 1.7 percent in the fourth quarter, along with 2 percent annual growth in 2013. Recent data suggests a possible downward revision for 2013. And unless the White House and Congressional negotiators reach an agreement soon, the economic impact of a fiscal impasse is likely to be severe - including a 2013 recession, according to the Congressional Budget Office. While the stock market has been jumping and stumbling in apparent response to incremental news on the Washington fiscal negotiations - A deal is on! No it's not! Yes it is! - the bond market has been eerily buoyant, Mr. Yardeni said. He coined the term "bond vigilantes" in 1983 to describe bond-buyers who punished the Reagan administration for its swelling budget deficits. "Now, " Mr. Yardeni said, "the Fed has stymied the bond vigilantes in the United States by taking bond rates as close to zero as you can get them." For the foreseeable future, he said, that market is likely to keep following the Fed's mesmerizing lead.