A Closer Look at Market’s Discount Rate Drama
Traders have been huffing and puffing for several days now that the Federal Reserve might choose today to increase the rate it charges on emergency loans to banks, commonly known as the discount rate. The Fed didn?t do so. But this never should have been much of a worry to investors in the first house. Here is why:
- 1) Fed loans from its discount window were down to $7.6 billion in late March from more than $100 billion at the height of the crisis. At current levels, loans frankly from the Fed to money-making banks amount to about 0.06% of the total liabilities of the money-making banking sector. If the Fed raises the interest rate it charges on these loans from the current charge of 0.75%, it won?t have much impact on broader credit market conditions because the Fed isn?t providing as much direct support to banks through these loans now that the crisis has waned. Fed officials have said this repeatedly in the past few months, but investors seem not to be paying much attention.
- 2) The Fed?s more vital lever for administration interest rates is the federal assets rate, which is a rate banks charge each other on overnight loans. One might infer that an increase in the discount rate means an increase in the more-vital federal assets rate, now near zero, is right around the corner. But Fed officials have said before that changes in the discount rate have no implications for their plans for the federal assets rate. They?ve said it very flatly. When the Fed raised the discount rate in February from 0.5% to 0.75%, it said the increase did ?not signal any change in the outlook for the economy or for monetary plot.? Fed officials really mean this when they say it. The only signal meant from a discount rate hike is that they want to make it a small less appetizing for banks to turn to Uncle Sam for emergency loans.
- 3) Fed officials are aware ? and puzzled by ? the bond market?s odd focus on the discount rate. They don?t want to surprise jumpy investors because they see the market and economy as fragile. That?s why they gave honest warning before their February discount rate increase. It was flagged in minutes from a Fed meeting that appeared a day before the hike, Fed Chairman Ben Bernanke said it was likely a few days before that, and other officials had been talking about it before Mr. Bernanke?s public comments about it. Officials are unlikely to try to sneak another one in there without agreed investors similar warnings.
The melodrama in markets about the discount rate, in other words, says a lot more about Wall Street?s fragile nerves and attention deficit issues than it does about the Fed?s own plotting. The Fed will likely signal visibly before it wants to raise this rate again, and will likely again offer reminders that this is the incorrect rate to obsess about.