We knew it was coming, but we didn’t know when. Now we know. After the stock market closed today in New York, the Federal Reserve announced it was raising its discount rate to 0.75% from 0.50%. This is the rate that the Fed charges on short-term loans to banks. Think of it as a down payment on the future.
Yes, the hike is both small and primarily symbolic. Lending through the Fed’s discount window is relatively slight in the 21st century. It’s hardly surprising that Bernanke and company chose to ease back into monetary tightening quietly. Nonetheless, a similar rise is probably near for the Fed funds rate, which is the central bank’s primary benchmark for adjusting the price of money. Currently, the target Fed funds is in a range of zero to 0.25%.
The burning question this evening: How will the markets react in the morning? The initial reaction in Asia is modest selling. Japan’s Nikkei 225, for instance, is off by around 0.7% as we write.
It looks like the era of the Great Easing is over in America. This is merely the first installment. Although the economy’s far too weak to warrant a rapid return to normal policy, today’s minor adjustment is a signal of things to come. The long road back to a normal monetary policy has started and there’s likely to be a few bumps on this journey.
“The Fed’s action came as a surprise and enhanced speculation that it will withdraw stimulus ahead of major peers,” Tomokazu Matsufuji, at SBI Liquidity Market Co. in Tokyo, tells Bloomberg News. “This will drive the dollar higher.”
Meantime, Chris Rupkey at Bank of Tokyo-Mitsubishi UFJ tells the LA Times this evening: “The Fed can talk all day about how the discount rate hike is technical and not a policy move, but the market sees it as a shot across the bow.” He went on to opine: “Today they raised the discount rate, and not tomorrow or the next day, but soon, they will be lifting the fed funds rate target as well, as the economy is starting to regain momentum.”
Finally, a few excerpts from a speech given earlier tonight by Dennis Lockhart, president of the Federal Reserve Bank of Atlanta. He spoke after the Fed announced it would increase the discount rate:
Earlier today, the Fed announced an increase in the primary credit rate. The primary credit rate—also called the discount rate—is the rate at which the 12 Federal Reserve Banks across the country provide temporary liquidity to healthy banks. How should today’s announcement be interpreted? I would not interpret this action as a tightening of monetary policy or even a sign that a tightening is imminent. Rather, this action should be viewed as a normalization step.
..the public and markets should not misinterpret today’s move. Monetary policy—as evidenced by the fed funds rate target—remains accommodative. This stance is necessary to support a recovery that is in an early stage and, in my view, still fragile.