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Fed Hikes the Discount Rate….$urprisingly Quick

Posted by Larry Doyle on February 18, 2010 4:50 PM |

The Federal Reserve indicated on February 10th it was going to raise the discount rate ‘before long.’ Well, in this case, Ben Bernanke is a man of his word as the Fed just raised the discount rate by 25 basis points (.25%) effective tomorrow.

While many market participants had minimized the potential rise in the discount rate as not being significant, I was not and am not in that camp. In fact, the speed with which Bernanke raised the rate after indicating that he would do so ‘before long’ has caught the market by surprise.

What is the immediate market reaction?

Equity futures have turned sharply lower; interest rates, especially for short maturity debt, have moved higher by 2-3 basis points; and the dollar has moved higher.

The Fed is putting out the story that this move should be minimized. The market is saying otherwise.

Market Watch adds further color on this development by writing, Fed Hikes Discount Rate, Says Not Tightening:

The Federal Reserve announced late Thursday that it was raising its discount rate in order to push banks to borrow from the private market for short-term credit. In a statement, the Fed said it would raise its discount, or primary credit rate, to 0.75% from 0.50% effective on Friday. Fed chairman Ben Bernanke signaled last week that the Fed was mulling the move. Fed watchers had expected the move to come at the next Fed meeting in March. Today’s action shows a sense of urgency on the part of the Fed officials. The Fed said the move is intended to “normalize” their operations as the financial crisis winds down. The change is not a tightening and does not signal any change in monetary policy, the Fed said.

Why did the Fed decide to make this move inter-meeting instead of waiting until March? What other surprises lay in store?

When the Fed raises rates, regardless of whether it is the discount or Fed Funds, rates go up. I expect more of the same as the Fed tries to ease its foot off the liquidity pedal.


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