Dollars and Jens
Friday, August 10, 2007
short-term interest rates
The fed funds rate opened at 6% today, a good 75 basis points above the fed's target, so the fed started pumping in liquidity, and reminded folks that that's what they'd do.
The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets.

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding.
There is, in fact, no there there — the announcement is that the fed still exists, and is doing fed-like things in exactly the way that was to be presumed — but it helps sometimes to remind the markets that the monetary system continues unabated.

There's talk of the fed cutting the target before the next FOMC meeting, and I'm rather not sure that would be wise:
Until the past few days, most monetary policy makers were emphasizing their concerns about mounting inflation pressures rather than problems emanating from the troubles of the U.S. subprime-mortgage market. But that may be changing. "This is a disinflationary event," said economist Richard Berner of Morgan Stanley. "If it continues, inflation risks are mitigated. That gives the Fed and other central banks latitude to step up the timetable for moving rates back to neutral or below neutral if necessary."
Well, maybe. Certainly when the two-year yield drops as quickly and as far as it has, it suggests the neutral interest rate is lower than it might have been before. If the fed is trucking money into the system to keep rates at 5.25%, though, it's not obvious to me what added benefit committing themselves to truck in even more money is likely to have.

More intriguing — and I've seen this mentioned a few different places, but all places our reader(s) might not see — is the idea that the fed might cut the rate demanded at the discount window, which currently stands at 6.25%. In ordinary market conditions, a bank willing to borrow at 100bp above the funds target is giving a hint that it must be in trouble, or other banks would be lending to it. At this point that may not be the case, and providing an easy way for banks to assure themselves that, regardless of what the fed funds market looks like, they can borrow directly from the fed at a premium of only 50 or even 25 bp might be a good idea for a few days, while we wait to see what happens next.

(By the way, the stock market was up for the week. Did you notice that?)

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