The Fed is about to get less predictable–and that’s not good
Just what we don’t need: Turmoil at the Federal Reserve.
On March 1 Federal Reserve vice-chairman Donald Kohn announced that he would be stepping down in June.
Kohn has been a key No. 2 to Fed chairman Ben Bernanke throughout the financial crisis. He led the stress test of big banks and efforts to coordinate the Fed’s actions with those of its global partners through the Bank of International Settlements.
Most importantly though he’s been head wrangler helping Bernanke keep the members of the Federal Open Market Committee, the Fed’s interest-rate setting body, relatively united on policy.
With the Federal Reserve facing a huge test of discipline—Can the central bank manage to gradually withdraw the stimulus it added to the economy during the crisis quickly enough to avoid a spike in inflation or in interest rates but not so quickly that it tips the economy back into recession?—Kohn the consensus builder will be missed.
Whatever you think of the policies he helped engineer, his departure makes the Fed just a little more unpredictable, a little more vulnerable to members leaving the reservation, a little more likely to spook markets with an ill-considered word at a time when the financial markets are already worried about the Fed’s ability to find the right course.
Kohn’s departure is likely to lead to even more truculence from inflation hawks such as Thomas Hoenig, president of the Kansas City Fed.
Are interest rate hawks pushing policy at the Federal Reserve?
Thursday’s Federal Reserve decision to raise the discount rate, the interest rate banks pay to borrow from the Fed, may not be the “no big thing” that chairman Ben Bernanke and the financial markets (so far) say it is.
The minutes of the January 14 meeting of the Federal Reserve’s board of governors and the regional Federal Reserve presidents released today, February 23, show that interest rate policy hawks may be driving Fed policy faster than Bernanke publicly acknowledges.
Markets decide Fed’s discount rate increase is no big thing
The financial markets have bought it.
The Federal Reserve’s move to increase the discount rate, the interest rate it charges banks to borrow money overnight, by 0.25 percentage points to 0.75% is part of “normalization” after the financial crisis and not a sign that the U.S. central bank is about to start raising its benchmark interest rate.
That’s how Fed chairman Ben Bernanke pitched the change. The U.S. financial system has recovered enough, he said, so that the Fed can begin with withdraw some of the support it offered during the crisis. In normal times the Fed sets its discount rate about 1 percentage point higher than its benchmark short-term rate now at 0% to 0.25%. The increase announced on Thursday, February 18, after the stock market had closed is merely part of a return to normal. So too is the end of an extension of overnight loans from the Fed to banks to as much as 30 days. Overnight loans will go back to being just overnight.
The financial markets, of course, didn’t have to buy into this interpretation.
The Fed expects strong economic growth too
I guess that counts as a fat reed.
Yesterday at 4:30 p.m. ET—just a minute after I posted my piece on thin reeds that argued that the U.S. economy was growing more strongly than many investors expected http://jubakpicks.com/2010/02/18/my-thin-reeds-say-the-first-half-of-2010-will-be-surprisingly-strong-in-the-u-s/ —the U.S. Federal Reserve raised its discount rate by 0.25 percentage points to 0.75%.
The discount rate is the interest rate the Fed charges banks to borrow funds. The Federal Reserve also went back to its normal policy of limiting such borrowing to a maximum term of overnight. During the financial crisis the Fed had increased the term of such loans to a maximum of 30 days.
The move indicates that the Fed believes that the U.S. economy is growing strongly enough for it to take this small step back towards business as usual. In that the move adds to the evidence that I cited yesterday for stronger-than-expected economic growth over the next quarter or two.
So when will the Fed raise rates? The schedule gets even more confusing
What’s the actual difference in months between “an extended period” and “before long?”
That’s what global financial markets are trying to figure out this morning after Federal Reserve chairman Ben Bernanke told the Financial Services Committee of the U.S. House of Representatives that the Fed may raise the discount rate “before long” as part of its plan to exit a period of extraordinary Federal Reserve intervention in the financial markets. The discount rate interest rate target is now 0% to 0.25%.
That’s a change from the Fed’s mantra, repeated for month after month after meetings of the Federal Open Market Committee that sets interest rate target, that low rates are warranted “for an extended period.”
But it’s by no means clear if the new language means the Federal Reserve will start to raise interest rates in three months or six or nine or ….
Count on the Fed to make a murky situation even murkier. How’s that possible?
