Bloomberg Business Week compiles comments from Wall Street economists and strategists on the key economic and market topics of Feb. 19.
Drew Matus, Bank of America Merrill Lynch
The Federal Reserve announced [on Feb. 18] that, effective Feb. 19, it would raise the discount rate (the primary credit rate, in Fed-speak) by 25 basis points to 0.75%.In the accompanying press release, the Fed stressed that this action represented a “normalization” of its lending facilities and does “not signal any change in the outlook for the economy or for monetary policy.” Despite this insistence that a larger spread of the primary credit rate over the interest-on-reserves (IOR) rate does not constitute a tightening of policy—and the fact that such a change was foreshadowed in both Chairman Bernanke’s testimony on Feb. 10 and the FOMC minutes released this past Wednesday—markets reacted swiftly, with equity futures selling off and the dollar strengthening.
[T]he Fed seems to have separated policies designed to unfreeze the financial markets (namely, the various lending and credit facilities) from those aimed at supporting the economic recovery (namely, the “extended period” of an “exceptionally low” fed funds rate and the large-scale asset purchases). At the January meeting, the FOMC had announced that, on Feb. 1, it would close a number of the alphabet soup of facilities it created since the onset of the crisis, and it would let the swap agreements with foreign central banks expire. It also had announced that the last TAF auction would be on March 8. Raising the primary credit rate represents a final step in winding down this set of programs designed to provide emergency sources of liquidity. The Fed stated that one goal of this change is to “encourage depository institutions to rely on private funding markets for short-term credit,” which should eventually restore the discount window to its original purpose as a “backup source of funds.”
Importantly, as the Fed went to great pains to reiterate, this action does not signal that an increase in the funds rate target or the IOR rate is imminent. Indeed, the formal implementation of the Fed’s exit strategy is still some time off, in our view—we continue to expect that the FOMC will not raise rates until early 2011.
Marc Chandler, Broth Brothers Harriman
The Federal Reserve announced it was lifting the discount rate to 75 basis points from 50 basis points. The timing has caught the market off guard, even though Fed Chairman Bernanke had hinted this was coming rather soon. However, even though the discount rate hike is a Federal Reserve Board decision, markets expected that the Fed would make such an announcement at an FOMC meeting. We had thought the meeting next month was mostly likely.
The decision to go between meetings is important. The Fed wants to drive home the message that it does not see this move as changing monetary conditions. That is to say that it is not tightening policy. This is properly understood as a incremental step toward normalization. There are many more steps to be taken before there is an increase in the Fed funds rate, or the rate paid on excess reserves. However, it is an important step, as incremental as it may be. In the current environment, it is unlikely to sway the market, which for the last three months has rekindled affection for the greenback that was so beaten up in the March-November 2009 period.
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