Given how extraordinary the Fed’s half point (not mere quarter point) discount rate cut of this morning was, and how the markets had been clamoring for it, you’d think we’d see more of a bounce in the Dow than the mere 160 ish points it is up as of this writing (that has come to constitute mere daily noise).
Of course, a discount rate cut is not a Fed Funds cut, but perhaps most important was the information content of this move. Bernanke has signaled that he is the true heir of “Greenspan put” Al. And in keeping, the language in the Fed’s statement shifted away from the threat of inflation, saying the risks to growth had risen “appreciably.”
And Bloomberg tells us of another unusual element of this loosening of credit:
Today’s action also includes an extension in so-called discount window borrowing, allowing 30-day financing that’s renewable….The central bank will “continue to accept a broad range of collateral,” including home mortgages and “related assets,” it said
The underwhelming response in the stock market is surprising given that this is an options expiration day and traders bet heavily on the short side. Per Toro at Seeking Alpha, who wrote this before the rate cut:
So the question is do we buy here?
If you are a trader, I think the answer is “yes.” I expect the market to rally, maybe hard, today and into next week. We are very oversold.
The technicals say we are. By almost every indicator I look at, we are at extreme levels. Also, as I understand it, today’s options expiration is leaning heavily to the puts, which will force market participants to buy stock to cover.
Perhaps the rumors of high put levels were overdone, or perhaps we’ll see a big move in the last hour.
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Mikhail Orlov’s comment in another blog:
“Let me get this straight. There is an overnight REPO inter-bank rate, set at 5.25%. There is a Fed discount window that used to be 6.25% and now 5.75%. Why someone in their right mind would pay more if cheaper overnight rate is available? Why any prime broker-dealer would ever use discount window?
Now, REPO apparently requires hard collateral such as US treasuries. Fed now is willing to accept MBS, which other banks refuse to lend against! That means we do not have a liquidity crisis! If that was the case – REPO rates must have been higher than Fed discount window rates. We have a crisis of banks not having enough “good” collateral and not trusting each other with all this MBS junk.
That perfectly explains why effective overnight rate has been well below Fed target rate. There is no demand for the inter-bank funds, demand that can be backed with required collateral!
With that, even if Fed lowers rate to zero – it is not going to help at all. Banks will not be willing to lend to each other because there is no collateral to lend against! “
I’m hoping that the Fed has enough intellectual firepower that this is actually a good move. If either the Federal Funds market is breaking down because of a lack of acceptable collateral (per Orlov quoted above) or the Fed’s anticipating future spikes in the FFR, this may be a move toward following Bagehot’s advice and lending at a penalty rate. Banks can get the accomodation they need but only at 50 basis points above the FFR. On the other hand the new crisis monetary policy can be to allow the FFR to fluctuate — with a cap at the discount rate. In other words I’m hoping there’s enough intellectual firepower at the Fed that this is actually a rate increase in disguise.
The Fed needs to experiment with what an acceptable spread between the rates is. A 100 point spread is probably too risky as a starting point for a huge monetary policy shift, but would have been a mighty low penalty rate by Bagehot’s standards.
Helpful stuff. Thanks.
Bur remember, Bagehot recommended lending at penalty rates against good collateral. The ABCP seize up is assumed to be a liquidity rather than a solvency crisis. But is all of it good? And even if it is good now, won’t some of it go into distress as the housing market deteriorates further?