×
Home Companies Industry Politics Money Opinion LoungeMultimedia Science Education Sports TechnologyConsumerSpecialsMint on Sunday
×

Inflation risks ignored as the Fed cuts overnight discount rate

Inflation risks ignored as the Fed cuts overnight discount rate
Comment E-mail Print Share
First Published: Tue, Aug 21 2007. 01 52 AM IST
Updated: Tue, Aug 21 2007. 01 52 AM IST
New York: It took a fair amount of kicking and screaming from financial markets last week to prod the Federal Reserve into action. But act it did, cutting the discount rate by 0.5 percentage point to 5.75% before the New York Stock Exchange opened on Friday.
The unexpected action had an immediate and positive impact on global stock markets, which reversed earlier losses. It took some of the bloom off the three-month treasury bill, whose rate had tumbled more than 100 basis points in the span of a week. And it reinforced expectations that the Fed was close to cutting the overnight benchmark rate, now at 5.25%, perhaps even before the next meeting on 18 September.
The Fed issued two statements, one technical, announcing the discount-rate cut and expanding both the type of collateral it will accept and the term of the loans; the other more touchy-feely.
“Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward,” the Fed said. “The downside risks to growth have increased...”
No mention of inflation. No nod to the “high level of resource utilization,” a statement staple for over a year. And the only concern about price stability was in relation to asset markets.
“The committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets,” the Fed said.
Begin the beguine
“It’s unusual to restate the statement,” said Jim Glassman, senior US economist at JPMorgan Chase & Co.
Less than two weeks ago, in a statement released after its 7 August meeting, policymakers were comfortable with their outlook for moderate growth and unsatisfied with the moderation in inflation.
How quickly things change, and how dramatically when they do. The inter-meeting action is significant for several reasons, not the least of which is the infrequency with which the Fed acts outside the scope of its eight regular meetings a year. The break reflects the near-panic conditions in credit, equity and money markets last week. It’s also an acknowledgement of how dicey conditions had gotten and the extent to which “the credit tightening is hurting the whole economy,” Glassman said.
Now the Fed has seized the day, although the absolute impact of lowering the discount rate, which had been 100 basis points above the target funds rate, will fall short of the psychological one. Banks won’t be lining up to borrow at 5.75% when they have other options open to them.
For example, one-month Libor (London interbank offered rate) was fixed at 5.51% on Friday. You don’t even have to be a bank to qualify.
As a practical matter, banks both here and abroad don’t want to lend for any period longer than overnight.
In the old days, there was a huge stigma attached to going to the Fed’s discount window. Evidence of unusually large discount-window borrowings from the Federal Reserve Bank of New York, for example, would spark rumours of a major financial institution in trouble. So banks avoided the window like the plague.
During the 1991 Gulf War, the overnight federal funds rate soared to 100% one day. Yet at least one bank paid that rate (overnight, at least), rather than go to the “window”.
The subprime market is getting worse. Delinquent home loans are piling up along with unsold homes. Last week saw Countrywide Financial Corp., the nation’s biggest mortgage lender, and “bankruptcy” (a possibility) mentioned in the same breath by a Merrill Lynch analyst.
Comment E-mail Print Share
First Published: Tue, Aug 21 2007. 01 52 AM IST