The Federal Reserve on Friday cut the discount rate at which it lends to banks by fifty basis points, to 5.75 per cent. The cut, agreed during an emergency conference call on Thursday night, was taken to “promote the restoration of orderly conditions in financial markets,” the Fed said announcing the move.
In a separate release, the Fed also seemed to move closer to an easing of the federal-funds rate, saying that “financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward….the Federal Open Market Committee judges that the downside risks to growth have increased appreciably.”
Results? Bargain hunting, says David Geffen at MarketBeat. Countrywide Financial, he notes, one of the most troubled stocks of late, rose sharply in the pre-market.
The FTSE 100 came back from midday losses to trade up more than 3 per cent on Friday afternoon, and US stock markets opened sharply higher on the surprise move.
But not everyone is impressed.
“In other words, the Fed’s inflation bias is crumbling. Bernanke’s knees are getting wobbly, but he seems to try all other means before having to cut the Federal funds rate target,” said analysts at Rabobank.
Stephen Stanley, at RBS Greenwich Capital, also took a sceptical tone:
At the risk of lifting the wizard’s curtain and ruining this gesture, I need to point out that a cut in the discount rate is not an ease, and in fact from the standpoint of mechanics is barely relevant, as borrowing at the window was minimal through Wednesday.
The Fed is no doubt hoping to capitalize on the past. Prior to 2003, when the discount rate was lower than the funds rate, cutting the discount rate was the most powerful tool in the monetary policy toolbelt. Indeed, prior to 1994, when the Fed began announcing changes in the funds rate target, a discount rate move was the ONLY move that was explicitly announced. Many market participants will think of the discount rate cut in those terms, which is not the correct way to consider it. Instead, this should be thought of as another (indeed, probably the last) intermediate step short of an ease.
Others even saw a darker explanation behind the Fed’s decision to cut the rate at which it provides liquidity to individual institutions in the event of an urgent short-term funding crisis.
Carl Weinberg and Ian Shepherdson at High Frequency Economics speculated that this cut, rather than a cut in the Fed funds rate, might suggest that the Fed anticipated some institutional failure “as soon as today.” Probably not a bank, they added - “but rather an institution that has substantial bank liabilities that may not be able to clear.”
They wrote:
Markets should not be calmed by this tactic. Unlike the Fed funds rate — which affects all banks’ cost of funds — a discount rate cut only lowers the cost of emergency borrowing by institutions in distress. This move is not going to provide any relief to the overall economy.
