The FED “surprised” the markets when it raised the discount rate after the equtiy markets had closed, which prompted a large buying of the DOLLAR and the selling of everything else. Earlier today, we wrote a piece about flattening and steepening curves and the impact they had on the markets. We thought the curve (2/10) would have flattened after the FOMC release but that did not take place and the markets all reacted positively to the renewed steepening action.
Post-FED action, the 2/10 Treasury curve has started to flatten, taking down everything in its path. We do not argue with price action so we respect what we are seeing at this juncture. We think that the DISCOUNT RATE RISE is not a big deal as it moves the discount to a 50 basis point premium to Fed Funds. The Federal Reserve statement went out of its way to ensure the markets that there was no change in monetary policy, but the market action dictated that we should pay no attention to the man behind the curtain.
To us this FED action indicates that the Fed is going to raise the rate on RESERVE DEPOSITS very soon as it begins testing its theory on how to remove the vast amounts of liquidity from the system. It will also prompt the use of reverse-repos soon, and by soon we think that could mean Friday. If the FED does initiate these next steps tomorrow, it should lead to more flattening of the curve and further selling of all risk assets. We will be watching closely for if the FED does indeed act and the markets were to slough it off, that would be the real story but that gets us too far ahead of ourselves.
At the end of the day a .75% DISCOUNT RATE is no big deal, especially when borrowings from the FED emergency facilities have been greatly reduced already. (And, as we need to remind everyone, if inflation is 1.5% and interest rates are still below 1% you still have negative real rates still feeding the market.) This is no time for heroes but rather cautious weighing of market action to truly signify if a sea change is upon us. As always-2+2=5 in an unbalanced world.
Tags: Fed
February 18, 2010 at 9:24 pm |
how does a reverse-repo remove liquidity? the fed as a buyer on settlement would deliver the security and take cash, but they would have paid a little less cash for the security on the date of the initial transaction, correct? is the interest payment component the attempt to remove liquidity? I must be missing something…
February 19, 2010 at 8:20 am |
[…] never “DISCOUNT” the pain caused by the markets – Notes from the Underground […]
February 19, 2010 at 8:27 am |
merely to remove liquidity from the system by exchanging treasury debt for cash—by removing cash from the system for a fixed time.The FED and others are now experimenting with the tri-party repo and this is an issue of collateral —but the fed is bent on moving how to remove liquidity with minimal disruption—steve liesman had it right this morning—all experimental at this point