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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.

LD

  • Bill

    Wonder if the latest PPI number had anything to
    do with it? Perhaps a coincidence, but
    it likely wasn’t a plus in the timing.

    • LD

      Despite the Fed’s statement, the futures market for Fed Funds has priced in a likely increase in rates sooner than previously expected.

      Perception of higher rates could feed on itself and become reality.

      Watch the 2yr very closely.

  • Larry Johnson

    LD,
    What liquidity pedal? That’s what is so alarming about this. As you know the credit markets are still constipated and this is going to tighten it even more, choking off fledging recoveries in the already weak housing markets. Ouch.

    Good piece.

    • LD

      LJ,

      Thanks for the plug!!

      I should have been more direct in that the liquidity pedal is merely pumping the $$ into the banking system but, as we well know, not into the economy.

  • TeakWoodKikte

    LD, With the IMF selling gold direct to the market, the Chinese dumping 35 billion in Treasuries, the piss poor Fed sales, and growing devaluation pressure on the dollar, I am wondering what else may have caused the Fed to flinch.

    Is this going to be some “big surprise”? What else could be a “known unknown?

    • Bill

      Rising commodities, especially oil, were
      probably a factor.

  • TeakWoodKikte

    “I’m shocked. Completely shocked,” Todd Schoenberger, managing director of LandColt Trading said of the Fed’s move to raise the discount rate. “It makes me wonder if the CPI number coming out tomorrow is going to be just absolutely horrible—maybe they got wind of something,” he said.

    Schoenberger expects the Fed to raise the federal-funds rate, the rate banks charge each other, at its next meeting March 17-18. He, like many traders, didn’t expect the Fed to make a move until the second half of this year.

    The analyst expects stocks to pull back from the Dow Jones Industrial Average’s recent three-day winning streak as a result of the Fed move.

    “Expect a dramatic selloff at the open tomorrow morning,” Schoenberger told CNBC.

    http://www.cnbc.com/id/35465481

    So many people were caught unawares of this. Odd.






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