Friday February 19, 2010

Friday February 19, 2010
Interesting move and timing by the Fed. They have their proverbial hands full in attempting to 'slowly' unwind all of the monetary assistance levers they pulled during the 'crunch time'.
Yet to be delved into is the immense ballooning of the Fed's balance sheet with asset purchases, how that will be unwound, and what that will do the financial market place when it does happen...
Additionally, the interest rate effect on the price of these held assets as well as all government debt as the rate curve begins to move upward...
The key question at this time is: does our economy have enough foundational strength to struggle through the undoing?

prb

Subject: S&Y PSG Morning Market Update for February 19th

* After the close of the equity market yesterday, the Federal
Reserve increased the Discount Rate by 25 basis points to 0.75%. The decision by the Fed to raise the discount rate apparently came as a surprise to some. But anyone who follows the comments by the Fed Chairman would have seen that this move was imminent. In keeping with his commitment to transparency, Chairman Bernanke very clearly signaled he was going to raise the discount rate in published testimony released February 10th.

From the Chairman's testimony: "Federal Reserve's Exit Strategy",
Committee on Financial Services, U.S. House of Representatives, 2/10/10:
"Also, before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate. These changes, like the closure of a number of lending facilities earlier this month, should be viewed as further normalization of the Federal Reserve's lending facilities, in light of the improving conditions in financial markets; they are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC."

- The Fed's move is less an indication of a change in monetary policy and is more in keeping with the ongoing process of reducing the financial system's dependence on measures that were put in place during the financial crisis to support the banking system. Along with yesterday's announcement regarding the hike in the discount rate, the Fed announced that effective March 18th, the typical maximum maturity for primary credit loans will be shortened to overnight. Loans under the primary credit facility had been for terms as long as 90 days. Also the final Term Auction Facility (TAF) auction will be on March 8th.

* We share the Fed's view that the hike in the discount rate does not reflect a change in monetary policy and indeed the outlook reiterated in the January FOMC minutes that "it anticipates economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period", the market nonetheless exhibited a typical knee-jerk reaction with yields increasing across the curve. With this morning's economic releases, bond yields have moved lower but equity futures are set to open lower (S&P futures down 4.6 points at 8:45 EST)

* This morning's CPI release provides further indication that while the economy is slowly recovering; a sharp spike in inflation is not on the horizon. The CPI for January increased 0.2%, below the consensus estimate of 0.3%. The December CPI was revised from an increase of 0.1% to an increase of 0.2%. The CPI ex-food and energy for January came in at a -0.1%, again below the consensus estimate. On a year-over-year basis, inflation at the consumer level is running at a 2.6% pace.