The cut in the interest rate on the Fed’s currency swaps with Europe has led to speculation that the Fed will have to cut its discount rate as well. I’m pretty sure that speculation is wrong.
The point is fairly simple: European banks will now be able to get one week dollar loans from the ECB at an interest rate of about 0.6 per cent. If a US bank needed to borrow dollars from the Fed and went to the discount window it would have to pay 0.75 per cent. That seems perverse.
Life just got a little easier for small depository banks in the US: the Fed cut the seasonal discount rate last night from 0.25 to 0.20 per cent. “Seasonal credit is available to help relatively small depository institutions meet regular seasonal needs for funds that arise from a clear pattern of intrayearly movements in their deposits and loans and that cannot be met through special industry lenders,” explains the Fed. The small move will have limited market impact, but the trend is significant. Seasonal discount rates fell to an all-time low of 0.15 per cent in November 2009, but climbed to 0.35 per cent during talk of green shoots in June. That upward trend has now almost entirely been reversed.
The seasonal discount rate has again been cut, confirming the trend reversal started in July.
Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities. The latter have presumably been hard hit by the oil spill.
Is this the beginning of a Federal Reserve versus regional bank split?
Three regional bank presidents indicated they thought the discount rate should be increased by 25 bp to 1 per cent, according to the minutes of the discount rate meetings, released today. None of the Fed governors voted for the action and the nine regional bank presidents also recommended against increasing the rate.
There was little news in today’s prepared testimony by Ben Bernanke, Federal Reserve chairman, on the exit strategy. Mr Bernanke chose not to talk about the discount rate except to say that lasts month’s increase should not be viewed as a monetary policy shift.
And he mostly went over what he had already said last month in terms of the sequencing of the tightening, with reverse repurchase agreements and term deposits ramping up before – or alongside – an increase in the interest rate on reserves. Scant if any change there.
But one shift in tone did stand out.
Ben Bernanke, Federal Reserve chairman, heads to Capitol Hill on Thursday for a hearing on the US central bank’s exit strategy.
With the latest FOMC statement out only a week ago, few economists are expecting any significant changes to the monetary policy outlook of “exceptionally low” rates for an “extended period”. But that does not mean there won’t be news coming out of Mr Bernanke’s mouth. One guess of several economists, such as Michael Feroli of JPMorgan, is that the headlines could be made by a discussion of the discount rate – the rate at which commercial banks can borrow from the Fed in a pinch.
References to the discount rate were notably absent from the FOMC statement last week – but that doesn’t mean the committee did not discuss it.
Capital Economics said in a note today that the Fed’s extended period language may be debated in its meeting next week, but the FOMC will not drop it. But, the group says, that doesn’t mean the meeting will be uneventful. There is a possibility that the Fed will continue to increase the discount rate over the fed funds rate. (Its first move toward discount rate normalisation came last month, when it raised the spread by 25bp to 0.75 per cent).
But Capital Economics said a change in the extended period language – that is, the language the Fed uses to signify that it won’t raise the federal funds rate for at least six months – would be premature given inflation and credit trends and also that the Fed will not want to make another significant change as it ends its asset purchasing programme.
Among the points Capital Economics make:
And finally – the Fed increases a rate. Of course, it’s the discount rate not the federal funds rate, and Ben Bernanke, Federal Reserve chairman, and others have been quite clear that raising the discount rate is not tightening monetary policy.
“Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve’s lending facilities,” the release said, echoeing written comments from Fed chairman Ben Bernanke last week. “The modifications 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, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC).”