Barring approval of chickens, goats and grandma's silver as collateral at the discount window, it seems the Federal Reserve is close to running out of non-interest-rate tools to boost liquidity in credit markets.
And amid signs of market stability, there is a growing sense that officials can wait until the Sept. 18 meeting of the Federal Open Market Committee to adjust interest rates, with expectations centering on quarter-point reductions in the federal funds and discount rates. "In terms of the minor changes, they've used up a lot," said Zach Pandl, an economist at Lehman Brothers. "It's conceivable there's something else out there," said Lou Crandall, economist at Wrightson ICAP. However, "I think we are getting to the point (when) anything they could do easily they would be doing right now," he said. Following its surprise 50-basis-point reduction in the discount rate to 5.75% on Aug. 17, the Fed last week clarified the types of collateral that could be used for short-term borrowing. On Friday, the Fed said banks could pledge asset-backed commercial paper for which it is the liquidity provider. "If this reduces the number of borrowers paying distress prices in the (asset-backed commercial paper) market, it would help alleviate one of the more visible signs of stress in the financial system at present," Crandall said in a research note. | |
| Fed Needs To Do More...But More Of What? | |
| The Fed last week also allowed exemptions for banks to lend more capital to brokerage affiliates and encouraged large banks to use the discount window. Several major banks did so last week. Those actions appeared to calm equity markets and parts of the credit markets. However, "at the end of the day, these actions will probably not be enough," said Tony Crescenzi, strategist at Miller Tabak, since "some of the credit previously extended by investors and banks will not be extended in the near future." Indeed, strong demand at Monday's Treasury auction of $43 billion in three- and six-month Treasury bills highlights that there's still much demand for the safest places to park cash. Other steps the Fed could take should conditions erode again include further expanding the types of collateral pledged at the discount window or by altering the "haircut" to determine the amount the Fed will lend on illiquid collateral. However, "if they're going to start splitting hairs between now and the (Sept. 18 FOMC) meeting, (saying) we'll decrease the haircut (on collateral), and they make all these steps shy of a rate cut, the market would get impatient and say 'come on already,'" said David Ader, chief bond strategist at RBS Greenwich Capital. "Recent stability is contingent upon further action from the Fed and can hence reverse if there is no further action from the Fed," said Miller Tabak's Crescenzi. He thinks the Fed will have to consider lowering the discount rate further towards the federal funds rate of 5.25% or cut the fed funds rate itself. "If there is no new money, the money that exists will stay parked in less-risky assets such as T-bills, providing too little relief," Crescenzi said. | |
| Bernanke's Jackson Hole Speech Eyed | |
Increased calm in financial markets coupled with recent durable goods orders and jobless claims data - which suggested the economy had enough momentum to withstand the recent credit crisis - have forced investors to back away from expectations of an intermeeting rate reduction. Still, many banks see the Fed lowering the fed funds rate by 25 basis points to 5% next month. And Ader at RBS Greenwich said the Fed would probably combine such a move with a discount rate cut as well since officials want to encourage discount window use to facilitate financing. It would probably take a direct signal from the Fed to get investors to back off those expectations. When the Fed lowered the discount rate on Aug. 17, it issued a rare intermeeting policy statement saying downside economic growth risks had risen "appreciably," which many Fed watchers took to suggest officials now have an easing bias. Since then, the only major economic remarks have come from Richmond Fed President Jeffrey Lacker. Though he stressed that inflation remains a concern, Lacker's speech didn't seem to sway investors from rate-cut bets, perhaps since Lacker is known to be one of the more hawkish members of the Fed and thus such statements aren't surprising coming from him. Fed watchers will closely eye a speech Friday by Fed Chairman Ben Bernanke at the Kansas City Fed's annual symposium in Jackson Hole, Wyoming, for clues. Bernanke has been silent since Aug. 17, though following a meeting last week between Bernanke, Treasury Secretary Henry Paulson and Senate Banking Committee Chairman Christopher Dodd, D-Conn., Dodd said Bernanke promised to use "all the tools available" to respond to market volatility. The topic of Bernanke's speech, housing and monetary policy, seems ideally suited to send a message to markets. But the timing might not be right, since economic data released in the days after Bernanke's speech will provide much-needed information about how the economy performed in August. "It's a very interesting set-up," said Wrightson's Crandall, but "we're not looking for a direct policy signal." | |
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