Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
Gold & Silver Stand Strong amid Stock Volatility & Falling Rates - 16th Aug 19
Gold Mining Stocks Q2’19 Fundamentals - 16th Aug 19
Silver, Transports, and Dow Jones Index At Targets – What Direct Next? - 16th Aug 19
When the US Bond Market Bubble Blows Up! - 16th Aug 19
Dark days are closing in on Apple - 16th Aug 19
Precious Metals Gone Wild! Reaching Initial Targets – Now What’s Next - 16th Aug 19
US Government Is Beholden To The Fed; And Vice-Versa - 15th Aug 19
GBP vs USD Forex Pair Swings Into Focus Amid Brexit Chaos - 15th Aug 19
US Negative Interest Rates Go Mainstream - With Some Glaring Omissions - 15th Aug 19
GOLD BULL RUN TREND ANALYSIS - 15th Aug 19
US Stock Market Could Fall 12% to 25% - 15th Aug 19
A Level Exam Results School Live Reaction Shock 2019! - 15th Aug 19
It's Time to Get Serious about Silver - 15th Aug 19
The EagleFX Beginners Guide – Financial Markets - 15th Aug 19
Central Banks Move To Keep The Global Markets Party Rolling – Part III - 14th Aug 19
You Have to Buy Bonds Even When Interest Rates Are Low - 14th Aug 19
Gold Near Term Risk is Increasing - 14th Aug 19
Installment Loans vs Personal Bank Loans - 14th Aug 19
ROCHE - RHHBY Life Extension Pharma Stocks Investing - 14th Aug 19
Gold Bulls Must Love the Hong Kong Protests - 14th Aug 19
Gold, Markets and Invasive Species - 14th Aug 19
Cannabis Stocks With Millennial Appeal - 14th Aug 19
August 19 (Crazy Ivan) Stock Market Event Only A Few Days Away - 13th Aug 19
This is the real move in gold and silver… it’s going to be multiyear - 13th Aug 19
Global Central Banks Kick Can Down The Road Again - 13th Aug 19
US Dollar Finally the Achillles Heel - 13th Aug 19
Financial Success Formula Failure - 13th Aug 19
How to Test Your Car Alternator with a Multimeter - 13th Aug 19
London Under Attack! Victoria Embankment Gardens Statues and Monuments - 13th Aug 19
More Stock Market Weakness Ahead - 12th Aug 19
Global Central Banks Move To Keep The Party Rolling Onward - 12th Aug 19
All Eyes On Copper - 12th Aug 19
History of Yield Curve Inversions and Gold - 12th Aug 19
Precious Metals Soar on Falling Yields, Currency Turmoil - 12th Aug 19
Why GraphQL? The Benefits Explained - 12th Aug 19
Is the Stock Market Making a V-shaped Recovery? - 11th Aug 19
Precious Metals and Stocks VIX Are About To Pull A “Crazy Ivan” - 11th Aug 19
Social Media Civil War - 11th Aug 19
Gold and the Bond Yield Continuum - 11th Aug 19
Traders: Which Markets Should You Trade? - 11th Aug 19
US Corporate Debt Is at Risk of a Flash Crash - 10th Aug 19
EURODOLLAR futures above 2016 highs: FED to cut over 100 bps quickly - 10th Aug 19
Market’s flight-to-safety: Should You Buy Stocks Now? - 10th Aug 19
The Cold, Hard Math Tells Netflix Stock Could Crash 70% - 10th Aug 19
Our Custom Index Charts Suggest Stock Markets Are In For A Wild Ride - 9th Aug 19
Bitcoin Price Triggers Ahead - 9th Aug 19
Walmart Is Coming for Amazon - 9th Aug 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Fed Raises Discount Interest Rate, Dollar Soars, Equity Futures Sink, What's It Really Mean?

Interest-Rates / US Interest Rates Feb 19, 2010 - 01:18 AM GMT

By: Mike_Shedlock

Interest-Rates

Best Financial Markets Analysis ArticleThe Fed has been talking about its "exit strategy" for quite some time. Few believed he would pull the trigger on anything soon. Yet, Bernanke, unexpectedly raised the discount rate headed into options expiration.


Please consider the Federal Reserve Discount Rate Announcement released after the market close on February 18, 2010.

The Federal Reserve Board on Thursday announced that in light of continued improvement in financial market conditions it had unanimously approved several modifications to the terms of its discount window lending programs.

Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve's lending facilities.

The changes to the discount window facilities include Board approval of requests by the boards of directors of the 12 Federal Reserve Banks to increase the primary credit rate (generally referred to as the discount rate) from 1/2 percent to 3/4 percent. This action is effective on February 19.

In addition, the Board announced that, effective on March 18, the typical maximum maturity for primary credit loans will be shortened to overnight. Finally, the Board announced that it had raised the minimum bid rate for the Term Auction Facility (TAF) by 1/4 percentage point to 1/2 percent. The final TAF auction will be on March 8, 2010. ....

The increase in the discount rate announced Thursday widens the spread between the primary credit rate and the top of the FOMC's 0 to 1/4 percent target range for the federal funds rate to 1/2 percentage point. The increase in the spread and reduction in maximum maturity will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve's primary credit facility only as a backup source of funds. The Federal Reserve will assess over time whether further increases in the spread are appropriate in view of experience with the 1/2 percentage point spread.

Unsustainable Course

That move comes on the heels of St. Louis Fed President Hoenig saying policy was on an unsustainable course as noted in "Three Paths Forward" - Kansas City Fed on Current U.S. Fiscal Imbalance, Hyperinflation, Printing.

From Hoenig ...

No Short Cuts

Finally, there are no short-cuts. We currently must adjust from a misallocation of resources. There is no way to avoid some short-term pain in fixing the fundamentals in our economy. It is inconvenient for the election cycle, and it is undeniably terrible to have at least 10 percent of the labor force out of work. But short cuts now mean people out of work again in only a few years because we again try and avoid difficult adjustments. Outlining a credible course for managing our debt for the future will accelerate the restoration of confidence in our economy and contribute importantly to sustainable capital investment and job growth.

Conclusion

As I mentioned in the beginning, the fiscal projections for the United States are so stunning that, one way or another, reform will occur. Fiscal policy is on an unsustainable course. The U.S. government must make adjustments in its spending and tax programs. It is that simple. If pre-emptive corrective action is not taken regarding the fiscal outlook, then the United States risks precipitating its own next crisis. ...

The only difference between countries that experience a fiscal crisis and those that don’t is the foresight to take corrective action before circumstance and markets harshly impose it upon them. In time, significant and permanent fiscal reforms must occur in the United States. I much prefer this be done well before anyone feels an irresistible impulse to knock on this central bank’s door.

Treasuries Decline After Announcement

Bloomberg reports Treasuries Decline After Federal Reserve Raises Discount Rate

Treasuries declined after the Federal Reserve raised the discount rate charged to banks for direct loans for the first time in more than three years to encourage financial institutions to rely less on the central bank for short-term borrowing.

“This is all about how to start draining excess reserve and implementing a tighter policy,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee. “It’s not overtly hawkish, but not an indication of perpetual dovishness or accommodation. This is a necessary step before they could do the rest of the sequence of events.”

The rate increase is another step in the Fed’s gradual retreat from its unprecedented actions to halt the deepest financial crisis since the Great Depression. The central bank has provided hundreds of billions of dollars in backstop credit to banks, bond dealers, commercial paper borrowers and troubled financial institutions such as American International Group Inc.

Fed Chairman Ben S. Bernanke and policy makers “have reiterated in every way that this does not signal a change in policy,” said Aaron Kohli, an interest-rate strategist at primary dealer Royal Bank of Scotland Group Plc in Stamford, Connecticut. “This is a normalization of policy. They worked hard to remove the stigma from the discount window, and now they are normalizing the rate.”

Change In Policy?

All the news articles on this hike are reiterating this is not a change in policy. Say what you want, but this appears to be a change in policy from doing nothing to tightening. At the very minimum this is likely to change perceptions about the resolve of the Fed's willingness to take its exit strategy seriously.

Krugman will no doubt be pulling his hair out, but Hoenig is correct: the present course is not sustainable.

The shocking thing to me is the announcement coming on Thursday before options expiration. This repeats the pattern (except in reverse), of Fed moves to cut the discount rate and the Fed Funds rate several time during options expiration week.

This is an important step, the first step always is. Yet it is only the first step. So, let's not get too excited until there is some follow through.

Slow Steps Expected

Bernanake is likely to go slowly, certainly with hikes.

Moreover, it will be relatively painless for Bernanke to start draining excess reserves. The reason is excess reserves do not play a role in bank lending as noted in Fictional Reserve Lending And The Myth Of Excess Reserves.

The only reason excess reserves are a problem is they interfere with the Fed's ability to tighten.

Because the Fed will drain those excess reserves before it tightens, Bernanke can slow his exit strategy implementation as much as he wants. In this regard, the market is likely to overreact, pricing in rate hikes by Bernanke that will come later rather than sooner.

What Does It Mean?

If Bernanke follows through with additional tightening measures, it's a signal that the Fed either believes the economy is strengthening or the Fed simply does not care. The latter seems to be the position of Hoenig.

Either way, this is very bullish for the dollar. I have the dollar index at 81.18 right now, a new high for the move. Note that the Euro cracked 1.35 to the downside, a new low for its move.

My target of 82.50 for the US dollar index set when the index was at 75 looks more than doable right now. The dollar index can get a lot higher than that. If the Fed starts hiking before the EU, we could see the Euro collapse to 1.15 or lower, with the dollar index challenging 90 once again.

In response to the Fed's move, Gold and silver are taking a big hit, yet one must respect the relative strength in gold vs. silver or other commodities. Gold is close to all time highs while silver, copper, and especially energy are nowhere close.

In the commodity sector, I still expect gold to outperform.

Important Takeaway

The most important takeaway from this is a potential change in the market's perception of what the Fed is likely to do, and when it may do it, in light of Bernanke's surprise move in options expiration week.

In an equity market as overbought and overloved as this one is, Bernanke's move heightens market risk. Ironically, the same holds true even if there is no follow through from the Fed. The reason being, lack of follow through will be an indication of deteriorating economic fundamentals.

I think Bernanke has seriously misjudged the strength of this recovery. The only alternative is the "we need to do this regardless" mentality of Hoenig has won out. Either way, risk is high and rising. There is little to like about equities in this environment.

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2010 Mike Shedlock, All Rights Reserved.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules