Fed Raised Discount Interest Rate

Surprise!

This Fed discount interest rate maneuver surprised the market, driving stock futures lower after the close of trading, but don't panic, it's not what you think...

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After the close of trading Thursday, the Federal Reserve announced a unanimous decision to raise the Discount Rate from 1/2 percent to 3/4 percent. Stock futures gave back nearly a full percentage point in the after market, as traders hurriedly misinterpreted this market normalizing action for a sign the Fed was shifting into reverse. However, Federal Reserve Chairman Bernanke made it plainly clear last week that his Fed would not raise the Fed funds target rate anytime soon.

This discount rate action simply represents a movement toward normalcy, and it is something the market should have been better prepared for. The problem is that Fed speak had been mostly focused on the conclusion of asset purchase programs. The market had concluded this would occur first, and we could worry about other things later. Bernanke went wrong by not signaling the discount rate action as he did the securities markets plan.

As the crisis took hold, the Fed had to do whatever it could to make useful capital available to financial institutions in a bind, and to ensure it would be as little burdensome as possible (low rates, long terms). But now things are improved, and the Fed needs to reduce its balance sheet. It is reducing the term limit on this intended short-term funding and raising the cost of such capital. It's just one action of many planned for the process of unwinding, and it's nothing to fear.

This change in the discount rate should have no affect on loan rates, CD rates, savings rates or credit card rates, but the market is worried about something else. The market is stressed that the Federal Reserve may tighten credit too soon and burden an already dragging recovery. We think it's clear that the Fed is not going to raise the Fed funds target rate anytime soon. The market looks ahead though, and so the dollar strengthened and stocks retraced. I expect smart money will prevail and this early reaction will be likewise unwound with the special discount rate.

In overseas banking news, the Bank of Japan (BOJ) kept rates steady as expected.

Producer Price Index

The Producer Price Index keyed the news wire on Thursday morning. Headline PPI increased 1.4% in January, well above the economists' consensus view for a 0.8% increase. The increase in the Headline figure was greatly influenced by a 5.1% increase in the energy index; more specifically, an 11.5% rise in gasoline prices. Core PPI still rose a troubling 0.3% though, where economists were looking for only a 0.1% increase. We accurately prepared you for this data in our "Week Ahead" copy, within which we noted an expectation for pressure from petroleum and foods pricing; and both played out as we said.

Weekly Jobless Claims

Weekly Initial Jobless Claims popped back up to 473K in the week ending February 13, up from the revised 442K posted the prior week. This is not good news for a market that had started to bank on slowing rates of job losses. The four-week moving average eased slightly though, to 467.5K.

Leading Economic Indicators

Leading Economic Indicators only gained 0.3% in January, after posting a 1.1% gain in December. Economists had forecast a smaller 0.5% gain, but the result was worse. The Fed (and other stimulus) continues to play a big role in LEI improvement, due to the low level of bank borrowing costs it has established. The spread between the overnight bank lending rate and 10-year Treasury Yield provides the lift, and it did so again in January. In this week's "Week Ahead" copy, I warned that, "While I can agree with this data forecast for January, I worry about February and the next few months ahead." Fed unwind activities go a ways toward pushing that forecast. My concern is confirmed, as the strongest drivers of gains in LEI have been on government stimulus. Now that the government is about to pull it away, how well will this economy stand on its own with near 10% unemployment? That's rhetorical...

Philadelphia Fed Survey

A few days after the New York Fed's manufacturing data showed improvement, the Philadelphia Federal Reserve reported Philly activity also gained- to 17.6 on the General Business Conditions Index. The index was seen improving to only 17.0 in February, from 15.2 in January. The new orders index had slipped two months in a row, but it gained ground in February, rising sharply to 22.7, from 3.2 in January.

Corporate Drivers

Google (Nasdaq: GOOG) was hopeful a hearing on its settlement with authors might work out favorably, but the judge grilled the parties involved and refused to rule too quickly. ADP (NYSE: ADP) met with analysts, and earnings were reported by Dell (Nasdaq: DELL), ABB, Inc. (NYSE: ABB), Akzo Nobel (OTC: AKZOF.PK), Ameren (NYSE: AEE), Apache Corp. (NYSE: APA), Arbitron (NYSE: ARB), AuthenTec (Nasdaq: AUTH), Avista (NYSE: AVA), AXA SA (OTC: AXAHF.PK), Barrick Gold (NYSE: ABX), Build A Bear Workshop (NYSE: BBW), Cabela's (NYSE: CAB), California Pizza Kitchen (Nasdaq: CPKI), CBS Corp. (NYSE: CBS), Clearwater Paper (NYSE: CLW), CryoLife (NYSE: CRY), Daimler (NYSE: DAI), Developers Diversified Realty (NYSE: DDR), Eclipsys (Nasdaq: ECLP), Gen-Probe (Nasdaq: GPRO), Harleysville Group (Nasdaq: HGIC), Hittite Microwave (Nasdaq: HITT), Home Properties (NYSE: HME), Hormel Foods (NYSE: HRL), Ingram Micro (NYSE: IM), j2 Global Communications (Nasdaq: JCOM), K-Swiss (Nasdaq: KSWS), Key Energy Services (NYSE: KEG), Life Time Fitness (NYSE: LTM), Lumber Liquidators (NYSE: LL), Marchex (Nasdaq: MCHX), Morningstar (Nasdaq: MORN), Nanometrics (Nasdaq: NANO), Newpark Resources (NYSE: NR), NEXEN (NYSE: NXY), Noble Energy (NYSE: NBL), Occam Networks (Nasdaq: OCNW), OGE Energy (NYSE: OGE), Penn West Energy Trust (NYSE: PWE), PGT, Inc. (Nasdaq: PGTI), Pool Corp. (Nasdaq: POOL), Pride International (NYSE: PDE), PSE&G (NYSE: PEG), Reed Elsevier (NYSE: RUK), Reliance Steel & Aluminum (NYSE: RS), School Specialty (Nasdaq: SCHS), State Auto Financial (Nasdaq: STFC), Stewart Information Services (NYSE: STC), Swift Energy (NYSE: SFY), TC Pipelines (Nasdaq: TCLP), The Nasdaq OMX Group (Nasdaq: NDAQ), Universal American (NYSE: UAM), Validus Holdings (NYSE: VR), VASCO Data Security (Nasdaq: VDSI), VCA Antech (Nasdaq: WOOF), Vectren (NYSE: VVC), Ventas (NYSE: VTR), Veraz Networks (Nasdaq: VRAZ), Wal-Mart Stores (NYSE: WMT), Washington Real Estate Investment Trust (NYSE: WRE), WellCare Health Plans (NYSE: WCG), Williams Companies (NYSE: WMB), Williams Partners (NYSE: WPZ) and Windstream (Nasdaq: WIN).


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