Special FX Report – When is a rate hike not a rate hike?
Here are the latest Financial News:
The Fed surprised the markets Thursday and hiked the discount rate 25bps to 0.75%. Stocks and commodities declined and the USD rallied to a nine month high in reaction to the Fed’s discount rate hike. Stocks and commodities rebounded from earlier losses and the dollar pared gains in reaction to Fed assurances that the discount rate hike was not a signal that the Fed is considering an imminent tightening of monetary policy. The Fed says that the rate hike was a technical action to start to normalize monetary policy. In a statement accompanying the Fed’s discount rate hike the Fed said that “the changes are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy.” Thursday’s discount rate hike was the first rate hike since December of 2008. The discount rate is the emergency lending rate that the Fed charges banks. The Fed will seek to maintain a 50bps spread between the Fed funds rate and the discount rate. The Fed funds rate is currently at 0 to 0.25%. According to the Fed’s Lockhart the Fed funds rate may remain at this level throughout 2010 as the Fed remains concerned about high unemployment and the strength of the recovery.
There are a number of reasons why the Fed elected to hike the discount rate. One reason for the discount rate hike is that the Fed sees the banking system strengthening. Another rationale for the discount rate hike is that the Fed wants to normalize monetary policy and begin to prepare for an eventual tightening of monetary policy. A tightening by the Fed is not likely to occur until the Fed sees employment growth and that the trend in employment growth is sustainable. The fact that the Fed hiked the discount rate was not as much a surprise as the timing of the rate hike. In testimony before Congress last week Fed Chairman Bernanke said that the Fed was considering the possibility of hiking the discount rate as one of the ways of normalizing policy and to start withdrawal of stimulus. Some argue that the Fed acted on Thursday because last week’s 10 year note auction was not well received and China sold a record amount of US debt in December. Foreign demand for US treasuries has declined. Because of the record US budget deficit the US will continue to auction a record amount bonds. If the Fed did not soon signal the start of withdrawal of stimulus, inflation fears might discourage foreign demand for US bonds and light a fire under the bond vigilantes.
Friday the US reported that CPI remains subdued with January core inflation reported to have declined by 0.1%. As long as US inflation remains subdued a tightening of Fed policy will remain far off into the future and a Fed funds rate hike is unlikely until late 2010 at the earliest. This suggests that initial selloff in the global equity markets and commodities and dollar surge was an overreaction to the Fed discount rate hike. So when is a Fed rate hike not a rate hike? when the rate hike means that no imminent tightening of policy is coming.
Source: Easy Forex
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