Showing posts with label interest rate. Show all posts
Showing posts with label interest rate. Show all posts

Friday, February 19, 2010

Fed Raises Cost of Emergency Loans to Banks, Spurring Talk of Tighter Credit

[0218bernanke] Getty Images

Fed Chairman Ben Bernanke speaks during a dinner at the Federal Reserve Building on Oct. 8, 2009

The Federal Reserve raised an interest rate it charges banks for emergency loans, and emphasized that a broader tightening of credit for consumers and businesses is still at least several months away. But the late-afternoon increase in the discount rate didn't have the muted impact Fed officials hoped for.

Stock futures and bond prices fell, and the dollar rose against the euro.

"The Fed can talk all day about how the discount rate hike is technical and not a policy move, but the market sees it as a shot across the bow," Christopher Rupkey, an economist at Bank of Tokyo-Mitsubishi, said in a note to clients.

Although it was not a surprise, the markets reacted negatively to the Federal Reserve raising the discount borrowing rate for banks. The News Hub panel discusses.

Fed officials had been signaling for some time that they intended to raise the discount rate as part of an effort to wean the banking system off government credit. On Thursday, after raising that rate by a quarter percentage point to 0.75%, it indicated that the move wasn't a precursor to a broad tightening of credit.

The move doesn't "signal any change in the outlook for the economy or monetary policy" and is "not expected to lead to tighter financial conditions for households or businesses," the Fed said. Instead, it said it was encouraging banks to return to private markets as their main source of funds and rely on the Fed only as a backstop.

The discount-rate move didn't affect the Fed's main policy tool, the federal-funds rate, a Fed-influenced rate that banks charge each other on overnight loans. That benchmark rate that filters through to other market rates. The Fed on Thursday reiterated the fed funds rate will remain near zero for an "extended period," which means at least a few more months.

Still, the federal-funds futures market, where traders bet on the future level of that key rate, signaled that the market now is anticipating movement.

Before the Fed announcement, that futures market was anticipating one increase in the fed-funds rate this year, and put the chances of a second rate increase by year-end at 28%. After the announcement, the market had raised the odds of a second rate increase to 50%.

The market reaction highlighted the communications challenge faced by the Fed. Fed Chairman Ben Bernanke took many unorthodox steps during the financial crisis. The return to more normal Fed policy also is likely to follow an unorthodox path punctuated with bouts of market-jarring uncertainty.

Fed officials view the economy as recovering, but still weak and thus not strong enough to justify tighter credit conditions more broadly. In the depths of the financial crisis in 2008, Fed discount window loans exceeded $100 billion. As of Wednesday, they were below $15 billion.

Before the crisis, the discount rate was a full percentage point above the fed-funds rate, a penalty meant to discourage banks from using it except in extreme conditions. In the opening act of the financial crisis in August 2007, the Fed reduced the gap between the two rates to encourage banks to borrow.

With Thursday's move, which is effective Friday, the gap between the fed-funds rate and the discount rate will be a half percentage point, up from a quarter percentage point.


The Fed also shortened the maturity on discount-window loans from 28 days to overnight, a condition that prevailed before the crisis.

Borrowing from the discount window has a stigma, even though borrowers' identities aren't disclosed. So banks initially were reluctant to tap it during the crisis. In response, the Fed initiated an alternative way to lend to banks—auctioning off funds in an what was called the Term Auction Facility. The auctions grew to as large as $400 billion during the crisis. On Thursday, the Fed raised minimum bids on these loans to 0.5% from 0.25%.

"I'd emphasize that the changes are simply a reversal of the spread reduction we made to combat stigma, and like the closure of a number of extraordinary credit programs earlier this month, represent further normalization of the Federal Reserve's lending facilities," Fed governor Elizabeth Duke said in remarks prepared for delivery Thursday evening.

Fed officials discussed the discount rate at their January policy meeting, and described the reasons for lifting the rate in the minutes of that meeting, which were released Wednesday. The timing of the announcement apparently was intended to emphasize that it wasn't a signal of an imminent tightening of credit.

Posted via web from The Newport Beach Lifestyle

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