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Let’s see. The Fed hiked a rate even though it wasn’t the policy rate. The Fed shortened a term even though it wasn’t the “normal” term. The Fed announced it as a surprise even though they have been saying they want to be transparent and prepare markets for changes in advance. And the Fed speakers then spent effort trying to explain why a discount rate hike at an inter-meeting move with a reduction in term is not a tightening action.

By using this surprise the Fed has introduced some confusion into markets. It doesn’t mean rates are going up tomorrow or next month or by mid-summer. But it does mean that an additional uncertainty has been introduced into market pricing. Interest rates will now reflect this uncertainty. The dollar strengthened immediately as one would expect it to do. Currency exchange rates are now the first thing to react to changes in policy. And this was a change in policy event though the Fed says it is not so.

Does this action mean that tightening actions are limited only to actions taken by the whole FOMC and not actions taken by the Board of Governors? Is that only true for tightening actions but not true for easing actions? Is policy applied asymmetrically? Do we have a central bank that lowers rates in emergencies with inter-meeting moves and calls that easing but changes and raises rates in inter-meeting moves and calls that something other than tightening? This action adds to the questions because of the way it was done.

Why surprise the markets? That is the one element which has not been explained.

If you do surprise the markets, then why go to great lengths to explain that you are not tightening and that the policy is the same as it was before the announcement. If it was the same as before the announcement, why make the announcement and why make the changes.

It certainly is not the same. Markets know it. The currency exchange rates know it. The Fed knows it. Something happened. Things are different.

We still do not expect the Fed to hike the Fed Funds rate significantly before the end of 2010. We still believe that the world’s short term interest rates will be between zero and 1% for all for this year and well into next year. We still think that monetary policy must favor an extended period of ease.

But the Fed has now added an uncertainty premium and markets are adjusting to it. That means somewhere, some mortgage will not get refinanced. And somewhere, some bond financing will cost more to accomplish. And somewhere, some US manufacturer who exports will face a headwind because the dollar is stronger and his foreign competitor can sell more cheaply than yesterday. And somewhere, some person is not going to get hired because this uncertainty has raised the risk of hiring to the employer.

That, friends, is a tightening.

David R. Kotok, Chairman and Chief Investment Officer
February 19, 2010

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For personal correspondence: david.kotok@cumber.com

As noted yesterday and earlier this morning, the surprise Fed discount rate hike has everyone guessing as to the motivations:

• Response to political pressures;

• Proof the Economy is improving;

• Inevitable ending of extraordinary accomodation;

This will be debated for a while, but the US markets will cast its verdict shortly.

Usually, I consider day to day market action nothing but noise. The exceptions come when there is an unexpected action that was not anticipated or discounted by traders.

Hence, there might be some message to be discerned if we: 1) gap down hard, then trade lower all day, closing at lows; b) gap down hard, struggle back near flat; iii) something else entirely.

The caveat is we should be reluctant to read too much into the knee-jerk reactions of millions hyperactive, adrenal-charged traders and increasingly, algo driven boxes.

Note the Fed’s statement with the discount rate hike:

“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 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 . . .”

However, smart Traders tend to react to and anticipate, deeds and actions, not words and speeches. To paraphrase Ralph Waldo Emerson, “I cannot hear what you are saying because what you are doing is speaking so loudly.”

From the BIS, a paper on the future of public debt, some lucid and helpful musings on the entitlement mess on the other side of the current sovereign debt explosion in OECD countries:

Hat tip Kedrosky

Yesterday’s surprise hike in the discount rate has US futures sharply lower, though the rest of the trading bourses seem hardly bothered by it.

Dollar is firmer, and Oil, Gold and Equities are pressured . . .

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via Bloomberg

Incidentally, I have no idea what the story is with all those gold ads.

I assume they are a form of content based ad words thingie. I mentioned Gold today and again earlier this week, and that might be the source . . .

At TED2010, Bill Gates unveils his vision for the world’s energy future, describing the need for “miracles” to avoid planetary catastrophe and explaining why he’s backing a dramatically different type of nuclear reactor. The necessary goal? Zero carbon emissions globally by 2050.

Unusual and Exigent: My First Year at the Fed
Governor Elizabeth A. Duke
At the Economics Club of Hampton Roads, Norfolk, Virginia
February 18, 2010

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Thank you so much for being here. It’s great to be home with so many friends, former colleagues, and former customers, and all of you who make Hampton Roads such a great place to live and do business. I am truly honored to receive the Economic Impact award from the Economics Club of Hampton Roads, joining such company as Paul Sarbanes, former senator from Maryland and coauthor of the Sarbanes-Oxley Act, and Arthur Levitt, former chairman of the Securities and Exchange Commission. By honoring me, you recognize the extraordinary work of all the talented, knowledgeable, and dedicated men and women of the Federal Reserve System. So I would like to take this opportunity to express my admiration for the Fed staff and my colleagues on the Board of Governors, especially Chairman Ben Bernanke. I witnessed firsthand the leadership, the concern for the U.S. economy, and the political courage the chairman displayed as he led us through this tumultuous time. I wholeheartedly believe that without the actions taken by the Federal Reserve to fight the financial crisis, our financial system would have frozen and the outcome for the economy would have been unthinkable. It is hard to believe that it has only been 18 months since I left here. So I thought I would tell you a little about what I have been doing.

I was officially sworn in as a member of the Board of Governors of the Federal Reserve System on August 4, 2008, at 8 o’clock in the morning. Just a half hour later, I attended my first meeting of the Federal Open Market Committee (FOMC). (The FOMC, composed of the Board of Governors and the 12 Federal Reserve Bank presidents, is the body that makes decisions about interest rates and other aspects of monetary policy.) Six weeks later I attended my second FOMC meeting. Normally, the Board of Governors convenes right after the FOMC meeting for a quick vote on Reserve Bank requests to change the discount rate. My second such meeting was anything but routine. We voted to lend $85 billion to prevent the collapse of American International Group, Inc. (AIG), whose failure at such a fragile time could have had disastrous results. In between those two meetings were some of the darkest hours of the financial crisis. On September 7, the Treasury Department placed Fannie Mae and Freddie Mac into conservatorship, essentially putting the government in charge of the mortgage giants. On September 15, Lehman Brothers filed for bankruptcy protection. A day later, a prominent money market mutual fund “broke the buck”–that is, its share price went below $1–sparking fears that no investments were safe as the financial crisis rapidly spread around the globe. That was the same day we made the loan to AIG–not exactly a lot of time to ease into a new job.

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After reading yesterday morning’s discussion “Deficit Hawks Want New (or double dip) Recession,” a friend emails the following:

“Let’s say I buy your argument that expenditures beyond annual government income during recessions and the immediate aftermath is preferred to cutting the deficit. OK, smart guy, where would you spend the money?”

I believe that policy makers need to address two issues — and do so while individuals and banks deleverage — meaning, no more leverage or individual debt:

These issues are unemployment, and the related demand destruction the recession caused.

How to fix that?

There are many suggestions, but I would go with:

1) Payroll Tax Holiday: Over the Summer months (June, July and August) — no employer or employee taxes need to be paid. That would amount to an immediate surge of spending cash (with no additional individual debt), especially amongst the poor and middle class.

2) Public Works programs — Rebuild the US infrastructure — Airport terminals, Shipping Port Security, Highways, National parks — all of these not only create jobs, but leave something worthwhile  after the fact.

Any other ideas? Use comments to discuss

For those of you who are convinced the worst is behind us, I’ll see you at the next recession . . .

The Federal Reserve just announced they are increasing the primary credit rate (generally referred to as the discount rate) from 1/2 percent to 3/4 percent. This action is effective on February 19.

Full press release after the jump . . .

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Most news is inter-connected by various degrees of separation. People, places, story lines — very often overlap. News Dots visualizes how recent topics in the news fit together, like a giant social network.

Subjects—represented by the circles below—are connected to one another if they appear together in at least two stories, and the size of the dot is proportional to the total number of times the subject is mentioned.

To use this interactive tool, just click on a circle to see which stories mention that topic and which other topics it connects to in the network.

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click for interactive program

via Slate