Fed Hikes Discount Rate

The timing has caught the market off guard. The Federal Reserve announced it was lifting the discount rate to 75 bp from 50 bp. Fed Chairman Bernanke had hinted this was coming rather soon. However, even though the discount rate hike is a Federal Reserve Board decision, that the Fed would make such an announcement at an FOMC meeting. We had thought the meeting next month was mostly likely. The decision to go between meetings is important. The Fed wants to drive home the message that it does not see this move as changing monetary conditions. That is to say that it is not tightening policy.

Treasuries extended their losses and the dollar extended its gains in relatively thin late NY turnover. This is properly understood as a incremental step toward normalization. There are many more steps to be taken before there is an increase in the Fed funds rate, or the rate paid on excess reserves. However, it is an important step, as incremental as it may be. In the current environment, it is unlikely to sway the market, which for the last three months has rekindled affection for the greenback that was so beaten up in the March-Nov 09 period. Euro slide through $1.35 would target $1.33 in the near-term. Sterling appears on its way toward $1.53. The dollar could rise toward JPY94.