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February 18, 2010

Discount Rate Hike

Obviously, the biggest news of today's session came after the session finished. The Federal Reserve announced a 25bp hike in the discount rate. The immediate effect was to slap gold for 12 bucks and silver for 30 cents. After yesterday's late-hour announcement by the IMF, precious metals bulls must be feeling quite weary. However, I noted in the comments section that I expected the IMF effect to be short lived... it was... and I will say here today that the discount rate hike will also be shrugged off... perhaps not overnight, but it be overcome. Why? Simply because the discount rate carries little more weight than of a symbolic nature.

The obvious question that comes to mind on news like this is, how much money is currently owed to the discount window? Let's have a look, shall we?

discount window borrowing

As you can see, more than three-quarters of the crisis-level balance has been paid off. So the Fed just raised rates 25bp on about $90B of debt. Even if discount window borrowing were to remain flat for the next 12 months, we'd be looking at taking an additional $2B out of the system. Does anyone seriously believe $2B is going to make a difference against the trillions that have come off the printing presses over the last 2 years? If you want to discuss game changers, wait until the Fed hikes the target Fed Funds rate a few hundred basis points, and then we'll talk. The Fed is doing nothing here but trying to jockey confidence levels, the dollar, or something else. Take your pick. But the bottom line is nothing material has changed with regard to monetary policy.

Now there is a reason why I think the discount rate announcement may take longer to shake off than the IMF shenanigans. The rally out of what we expect to be a intermediate (and yearly) cycle low has been less than spectacular.

s&p 500 daily chart

An advance out of an intermediate low should have no trouble powering through the 65DMA. The fact that price has so timidly approached the moving average (note the declining volume) tells us not to rule out a test of the low before things get rolling. Such a move would certainly test our patience, as well, but it cannot be dismissed just yet. Now, perhaps I will be wrong and market will scoff at the Fed by gapping higher tomorrow morning. I, for one, would welcome a quick resolution as opposed to dragging the process out. But either way, I expect both stocks and precious metals to launch once the Fed fear dissipates. There is no better aphrodisiac for markets than overcoming bad news.


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