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What’s Happening Today-The Fed Speaks Loudly Wielding a Big Stick

Posted At : February 22, 2010 2:29 PM

Late last night, under the cover of darkness, The Federal Reserve increased the discount rate by 25 basis points to 0.75%. Even though this was expected, the question remains: are they just easing off the gas or are they stepping on the breaks?

On the surface, this looks like a rather benign move. The Fed’s decision is less an indication of a change in monetary policy and is more in keeping with the ongoing process of reducing the financial system’s dependence on measures that were put in place during the financial crisis to support the banking system.  Along with yesterday’s announcement regarding the hike in the discount rate, the Fed announced, effective March 18th, the typical maximum maturity for primary credit loans will be shortened to overnight.  Loans under the primary credit facility had been for terms as long as 90 days. The final Term Auction Facility (TAF) auction will also be on March 8th.  The good part is that this is In keeping with Chairman Bernanke’s commitment to transparency, which he has very clearly signaled he was going to raise the discount rate in published testimony released February 10th.

Although the charity has to end at some point, but is the economy strong enough to withstand it? Back in 1937 the Fed had a similar decision to make. The market had rallied 400+% from the lows of 1933 and the Fed decided that all was back to normal and started raising rates. This proved to be catastrophic as the stock market then fell 49.1% in one of the worst bear markets in history to this day. It didn’t recover until 1954.

The good news reported today is that inflation is nil. The CPI for January increased 0.2%, below the consensus estimate of 0.3%.  The December CPI was revised from an increase of 0.1% to an increase of 0.2%.  The CPI ex-food and energy for January came in at a -0.1%, again below the consensus estimate.  On a year-over-year basis, inflation at the consumer level is running at just a 2.6% pace, which is considered nothing. This strengthens my long held belief that deflation is the order of the day, and the Fed will do whatever is in its power to generate some inflation. I know this sounds ludicrous, but their playbook relies on economic growth, thus inflation, to pay off the deficit. The government thinks they can moderate the speed of the economy, inflating and deflating when necessary. I don’t know about you, but given their history of meddling in our free market society, I fear for the long term.

Regards – Keith Springer

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