Friday, February 19, 2010
Well, well, well. Yesterday's fixed-income polls proved to be very well-timed indeed; Macro Man cannot help but wonder whether we would once again see 55% of the respondents vote for "no FF hike this year" if the same question were put to them again this morning. Somehow, he thinks not.
The Fed has tried very hard to downplay the significance of last night's discount rate hike. Ex-ante, the minutes of the January FOMC meeting noted that a discount rate hike did not carry on specific implications for monetary policy. In real time, the accompanying statement said the same thing. And ex-post, Messrs. Bullard and Lockhart also downplayed the policy implications of the move.
This is all well and good, of course, but from Macro Man's perch to suggest that the move is utterly devoid of meaning is patent nonsense. First, and most prosaically, if the move had absolutely no meaning then there would be no point in doing it. Even if it was just intended to phase into an ECB-style "corridor" mechanism for Federal Reserve lending and deposit facilities, the widening of the spread between funds and the penalty borrowing rate will have some impact.
After all, it's notas if the Fed discount window is like the ECB marginal lending facility- used for a couple of days around MRO maturities, and then lapsing into disuse. Discount window borrowing, while well off the peaks of the crisis, is still pretty considerable- nearly $90 billion last week. That little 25bp hike has just added nearly $220 million to the annualized borrowing costs of those institutions paying a visit to the discount window.
Finally, it's worth recalling that the Fed's initial policy gambit in the entire crisis was a discount rate cut on August 17. They also cut the discount rate on Sunday, March 16, during "Bear Stearns weekend" before trimming both the disco rate and the Fed funds rate two days later. So it's perhaps a bit disingenuous to suggest that raising the discount has no meaning when they certainly intended it to have meaning when they were cutting it! Moreover, there's nothing to suggest that "extremely accommodative" policy necessarily means FF at 0 - 0.25%. After all, consensus calls for a steady stream of positive growth quarters this calendar year; if that forecast is realzied (and yes, it's a big if), one could credibly argue that rates 100 bps higher than current levels would still be "extremely accommodative."
Now, to be clear, Macro Man does not expect a FF hike this year. He does, however, look for reserves to be drained and believes that there's a decent risk that LIBORs tick up as a result (we're already seeing that in the UK, for example.) And so from a market perspective, he has little interest in owning the front end at current levels. If we look at EDZ0 and compare it with ED4 over the past few contract cycles, we can see that it looks pretty rich (though less so than a few weeks ago, in fairness.)
ED6, meanwhile, is in the middle of the pack. Of course, none of those prior contracts traded in to the context of a discount rate hike and possible draining of liquidity. And there was still a bum-clenching decline in the second and third quarters of last year- declines that occurred with much less open interest in ED6 than the current iteration of the contract has.
So while the Fed and much of the sell side are claiming that the discount rate hike "don't mean a thing", given current market pricing Macro Man ain't biting. If the labour market improves and CPI starts registering UK-style upside surprises, would you really be surprised if there was another 40-50bp bum clencher in ED 4-8? In many ways, it would be a surprise if there weren't one. So Macro Man is content to remain on the sidelines for the time being; far better to wade in when the blood is flowing than trying to ford the river at high tide.