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Economists Warn Fed Could Hike Discount Rate Before Next Meeting

March 18th, 2010 Michael McDonough

Economists and investors alike are speculating that the Fed could announce a second hike to the discount rate, after increasing its spread over the fed funds target rate to 50bps–compared to its historical level of 100bps.    Some investors, despite Fed comments to the contrary, perceived the move as prelude to more significant tightening, be it through a reversal of quantitative easing and/or eventual rate hikes.  Further adjustments could have a similar psychological effect on investors, especially given expectations that the Fed could remove or alter the phrase ‘extended period’ from its statement as early as April’s meeting–a clear sign tightening is quickly approaching.

Fed Funds Target (white) Vs. Discount Rate (orange):

According to the latest Federal Funds Implied Probability data, calculated by Bloomberg, the vast majority of investors anticipate no changes to the Fed’s target in April, but looking further out that number diminishes to  66.5% in June.  In an environment of high unemployment, subdued inflation, and what could be tepid growth, I expect August would be the earliest we could expect a Fed rate hike.  Nevertheless, news of another discount rate hike will almost certainly reverberate through the markets, spooking some skittish investors.

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