Market Mover - BNP PARIBAS - Investment Services India

US: Roadmap to Fed Tightening
• Chairman Bernanke carefully distinguished
between policies aimed at providing emergency
liquidity and more traditional monetary policy in
his testimony on Wednesday.
Chart 1: Effective Fed Funds Has Been Volatile
• Emergency liquidity programmes have been
almost completely phased out, with a hike in the
discount rate and the end of the TAF and TALF
programs the likely next steps.
• The most likely sequence of monetary policy
tightening will involve a draining of excess
reserves well before the first rate hike, and the
target policy rate shifting to the rate paid on
reserves. Asset sales are a last step in an
extremely frothy macroeconomic scenario.
• There is little in the testimony to change
expected timing of policy tightening, which will
still be determined by the evolution of the
economic recovery.
Emergency liquidity policies are near an end as
financial market conditions normalise
On a day when Washington DC found itself
snowbound, making it impossible for Chairman
Bernanke to appear before the House Financial
Services Committee as scheduled, the Federal
Reserve nonetheless released his testimony. The
testimony provided more details and specifics than
we had seen previously about the likely sequence of
actions the Fed will take as it transitions away from
an extremely accommodative policy stance. That
said, the speech did not change our expectations of
the timing of eventual rate hikes and markets were
little changed on balance after the release of the
testimony.
Chairman Bernanke clearly distinguished between
emergency liquidity policies the Fed put in place “in
its role as liquidity provider of last resort” and those
that allowed the Fed to effectively push through the
zero bound on interest rates in an effort to stimulate
economic activity. Emergency liquidity policies
included a number of programmes that provided
short-term funding to distressed markets. In his
testimony, Chairman Bernanke indicated that, “as
was intended, use of many of the Federal Reserve's
lending facilities has declined sharply as financial
conditions have improved”. He signalled that the next
step in ending this emergency lending role was a
“modest increase in the spread between the discount
rate and the target Federal funds rate” that will be
considered “before long” as well as a reduction in the
maximum maturity of discount window borrowing to
Source: Reuters EcoWin Pro
Chart 2: Banks And Credit Still Contracting
Source: Reuters EcoWin Pro
28 days from 90 days. Prior to the crisis, the spread
between the discount rate and Fed funds was 100bp
and loans that were generally overnight were
lengthened to 90 days. Furthermore, he indicated
that he anticipates that funding through the Term
Auction Facility (TAF) and the Term Asset-Backed
Securities Loan Facility (TALF) “will also be phased
out soon”. He stressed that “These changes, like the
closure of a number of lending facilities earlier this
month, should be viewed as further normalization of
the Federal Reserve's lending facilities, in light of the
improving conditions in financial markets; they are
not expected to lead to tighter financial conditions for
households and businesses and should not be
interpreted as signalling any change in the outlook
for monetary policy, which remains about as it was at
the time of the January meeting of the FOMC.”
Julia Coronado 12 February 2010
Market Mover
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