The US Federal Reserve appears to be flexing its independence with its sudden decision to raise the interest rate it charges on emergency bank loans though stock markets gave it a thumbs down.
Few would have guessed that the first major move by the Fed chief Ben Bernanke after beginning his second term in office on February 1 would be to raise the discount rate for the first time since the country plunged into recession in December 2007.
The Fed announced after the stock markets closed on Thursday that it was hiking the discount rate, or the primary credit rate, to 0.75 percent from 0.5 percent beginning Friday for short-term loans to banks.
It roiled financial markets as investors feared the US central bank might be moving faster than anticipated to withdraw critical support measures for the US economy limping out of a brutal recession.
“By increasing the discount rate, the Fed says it is encouraging banks to ‘rely on private funding markets for short-term credit,’” said Jan Hatzius of Goldman Sachs.
“In practice the effect is relatively small.”
But investors were particularly concerned that the central bank was setting the stage for tightening the federal funds rate, the benchmark interest rate that banks charge each other for overnight loans now at virtually zero percent.
“Mr. Bernanke… tell us that you have evidence that we do not yet see. Evidence that the economy is improving enough to start hiking rates,” said Greg Donaldson, director at Donaldson Capital Management, an investment advisory firm.
“The good news in the discount rate hike is the implication that the Federal Reserve now believes that the fed funds market has healed and that banks no longer fear each other’s balance sheets the way they did a year ago,” he said.
Although the markets were caught flat-footed by the Fed move, Bernanke had signaled just last week that the discount rate would be raised “before long.”
“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,” said Larry Doyle, a former Wall Street trader.
“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.”
Analysts at Barclays Capital believed that any exit by the Fed from its current monetary stance had the potential to deliver volatility to the rates market.
“We interpret these changes as additional steps to withdraw some of the extraordinarily accommodative policies the Fed put in place during the crisis,” said Barclays analyst Michelle Meyer, referring to the discount rate hike.
In an unprecedented move, the Fed at the end of 2008 slashed the benchmark fed funds rate to a range of zero to 0.25 percent and pumped hundreds of billions of dollars into the economy to jolt the world’s largest economy from the recession.
“We continue to believe that the Fed will engage in large-scale reserve draining activities mid-year and begin hiking (benchmark) rates in September,” Meyer said.
Americans may eventually have to bid goodbye to the era of easy money.
“It looks like the era of the Great Easing is over in America,” said James Picerno, a financial consultant.
He said the discount rate hike was “merely the first installment.
“The long road back to a normal monetary policy has started and there’s likely to be a few bumps on this journey.” Commercial Loan Workout.
Pages: