Fed Raises Discount Rate to 0.75% From 0.50%

Market mover for the day. Dollar was very bullish last night even though the news was released after close!

Published: Thursday, 18 Feb 2010 | 6:00 PM ET Text Size By: CNBC.com with Reuters
The Federal Reserve said on Thursday it raised the interest rate it charges banks for emergency loans but insisted that its first rate move since December 2008 would not raise borrowing costs for consumers or companies.

The Fed cast its decision to raise the discount rate to 0.75 percent from 0.5 percent as a response to improved financial market conditions that warrant less of a helping hand from the U.S. central bank.


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It went to pains to draw the distinction between the discount rate and its target for overnight interbank rates, its main monetary policy tool, which remains unchanged near zero percent as a fragile U.S. economic recovery struggles to gain traction.

"Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve's lending facilities," the Fed said in a statement.

"The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy," it said.


Market watchers were shocked by the announcement, which came after markets closed Thursday.

“I'm shocked. Completely shocked,” Todd Schoenberger, managing director of LandColt Trading said of the Fed’s move to raise the discount rate. “It makes me wonder if the CPI number coming out tomorrow is going to be just absolutely horrible—maybe they got wind of something,” he said.

Schoenberger expects the Fed to raise the federal-funds rate, the rate banks charge each other, at its next meeting March 17-18. He, like many traders, didn't expect the Fed to make a move until the second half of this year.

The analyst expects stocks to pull back from the Dow Jones Industrial Average's recent three-day winning streak as a result of the Fed move.

"Expect a dramatic selloff at the open tomorrow morning," Schoenberger told CNBC.

The increase in the discount rate “does not mean that the Fed is ready to hike [the fed-funds rate] or has a set time for such a move. But it does mean that the Fed is preparing the way,” said Robert Brusca, chief economist at FAO Economics. “This is very much a move to prepare markets and to test markets to see if they are ready to absorb a rate increase by putting the Fed’s lending vehicles back in a normal configuration,” he said.

'Bullish for the Dollar'

The U.S. dollar reached its highest point against the euro since May of 2009 after the Fed's announcement Thursday.



“I think it’s very bullish for the dollar,” said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. “It cements the U.S.’s safe-haven status for foreign investors,” he explained.

Gold prices fell as a result of the news.

U.S. light, sweet crude futures surrendered some of their earlier gains to move near $78 late Thursday, after settling $1.73 higher at $79.06 a barrel.

Pimco Founder and Co-Chief Investment Officer Bill Gross said he sees the Fed's action as part of a much larger pullback from the government's economic stimulus strategy.

"This move is more of a classical monetary policy maneuver ... as opposed to the beginning of an interest rate increase or any tightening from the standpoint of interest rates, and I think that’s what's critical for bond investor," Gross said.

The Fed also said that as of March 18 the maximum maturity for primary credit loans will be shortened to overnight. It also said it was raising the minimum bid rate for its term auction facility program from 0.25 percent to 0.50 percent and that the final TAF auction will be on March 8.

The TAF program allows depository institutions to bid on loans from the Fed using a wide range of securities and assets as collateral. It was introduced in December 2007 as a way to introduce liquidity for financial institutions amid credit market concerns about the quality of securities being used as collateral.