FED FOCUS-Fresh Fed liquidity steps suggest rates on hold
Wed Jul 30, 2008 1:35pm
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WASHINGTON, July 30 (Reuters) - Fresh measures announced on Wednesday to boost capital market liquidity show the Federal Reserve wants to maintain easy finance and suggest it will probably keep interest rates on hold for months to come.
Economists said that Fed steps to aid efficient market operation ought to be viewed separately from its monetary policy actions but the central bank will want to avoid hiking borrowing costs while the credit climate remains so fragile.
"I think it is highly unlikely that they would raise rates under these conditions and given what they are trying to accomplish with these facilities," said Brian Bethune, chief U.S. financial economist at Global Insight in Lexington, Mass.
He reckoned that the measures would ease interbank financing conditions by a quarter percentage point or more, giving some of the same benefits of an actual rate cut without any of the problems of intensifying concerns over inflation.
"Today's announcement does not prevent tightening under all circumstances, but it does indicate that the inflation threat has to be substantial enough to overcome a still questionable outlook for growth," wrote former Fed Board Governor Laurence Meyer, who is now with Macroeconomic Advisers.
Others remained more hawkish. Financial market futures currently signal that investors give a 68 percent likelihood the Fed will have lifted rates by a quarter point by its presidential election-eve policy meeting on Oct. 28-29.
The Fed has extended the Primary Dealer Credit Facility, the access it granted investment banks to its discount window emergency cash around the time of the Bear Stearns rescue, until Jan. 30. It has extended another credit, called the Term Securities Lending Facility and which is also designed for investment banks, by the same amount of time.
In addition, it is offering to auction options on the TSLF around tricky funding periods like quarter-end, is introducing an 84-day Term Auction Facility to compliment an existing 28-day TAF, and has increased its swap line with the European Central Bank.
"These facilities would be withdrawn should the Board determine that conditions in financial markets are no longer unusual and exigent," the Fed said in a statement.
This explicit acknowledgment of how worried the Fed remains about market conditions pointed toward a prolonged period of monetary policy inaction.
"It's very difficult to see how the Fed can raise rates while a declaration of "unusual and exigent" circumstances is in place," said Morgan Stanley economist David Greenlaw in a note to clients. "Thus, we continue to expect monetary policy to remain on hold for the foreseeable future," he said.
The authority of the Fed -- the U.S. central bank -- to create these tools is drawn from the Federal Reserve Act, which requires it to find market conditions are unusual and exigent.
It has slashed benchmark overnight U.S. borrowing rates by 3.25 percentage points to 2 percent since mid-September to shield the economy from a credit crunch sparked by losses in risky subprime mortgages that has chilled growth.
Economists did not want to completely rule out the chances of a rate hike, given the risks of a ratcheting-up of inflation pressures if the dollar collapsed, but thought the probability should be given a low weight.
"It does mean the bar is somewhat higher for raising rates, although I do think that under the right circumstances you could have the Fed raising rates while these facilities are in place," said Dean Maki, chief U.S. economist at Barclays Capital in New York.
"These things are mixed together, but they are not one and the same." said Maki, who sees the benchmark overnight fed funds rate on hold at 2 percent until early next year. (Editing by James Dalgleish)
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