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.”

Category: Federal Reserve, Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

39 Responses to “What Can the Market Tell Us About Surprise Fed Action?”

  1. Paul B says:

    I think the timing of the DR hike is telling, despite half-hearted efforts by the Fed to play it down. If it was chosen to be the day after the minutes to mollify FOMC hawks, then it shows Bernanke is still being political first and reckless with collateral values (stocks/real estate) second. If it was chosen to show inflation hawks in the market that the Fed shares their fear, then the toothless nature of the hike rings hollow and shows the desperation of a body that can only jawbone rates and which will not be able to truly drain reserves anytime soon. Whatever the case Bernanke seems like a rank amateur. Duration holders should truly be fearful and the curve should steepen further, eh?

  2. Scott F says:

    The concern about next week’s auctions makes sense to me–after last week’s, a fear that they’re losing the bond market– and a meaningless gesture is the best that can be mustered. Apparently Gary Shilling, who’s been a dollar bull forever, was on Bberg radio or tv last night saying euro-$ goes to parity. Can you imagine what that will do to our exports? Bill King makes the amusing point this morning that after months-years of talking tough and doing nothing, the Fed now does not much, but something, and immediately sends its minyans out to talk nice, and proclaim that there is no change. Stephanie and I agreed last night that we’ll take all bets against the proposition that the Fed’s balance sheet is larger at year end than it is today.

    In all fairness, Paul, wrt the toothless nature of the hike, Bernanke’s not exactly holding any powerful hole cards, all his reverse repo and interest on excess reserves legerdemain notwithstanding.

  3. torrie-amos says:

    well, even though i’m a broken record, i is a strategist, last year i worked a matrix on ben path too success

    containment of commodity prices, thus, good old earl has to be contained, thus i still stand by

    85 oil, and all bets are off, that is a huge tax on all and an economy killer

    face it we handled 140 with massive leverage, w/no leverage 85 says it all to me

    volatility of costs screw up bizz’s budgets, these things are so whacked we need calmness

    if earl stays below 85 in the 70 range, rotation rotation rotation

  4. flipspiceland says:

    Curious as to how many here were “surprised”?

    Anyone but BR?

  5. globaleyes says:

    I think the floor has been raised. MMF yields have just jumped 50%. Despite what BR thinks about Bernanke, I like the Fed’s surprise move. Ben exercised his options. I expect “duration holders” (nice term) will be disappointed, too. But let’s face it: there aren’t many long bonds left, right?

    If I like you, I kill you last.


  6. torrie-amos says:

    i wasn’t surprised, imho, bens scared shitless about contagion

    rule of 3, dubai, greece, iceland, although not recent enough, you had bond failures in europe, u can only push insanity so far, also he’s come out 3 times in last 2 months that end of march is a line not too be crossed, imho, if he renigs on that one, the crys of socialism would be velly loud

  7. Mike in Nola says:

    “algo driven boxes” ? You’re beginning to sound like ZH :)

    Scott F: Yeah, BB and the rest are stuck. Trouble selling bonds if the rates are too low and too much money printed. OTOH, the trade war requiring depreciating the currency to compete is still in its early stages requires low rates. Raising rates kills exports. What is a poor Keynsian to do? I assume your statement means you think QE restarts sometime this year once the babystep tightening starts collapsing the current bubbles. Agree with that.

  8. Marcus Aurelius says:

    Ben decides to make the dollar stronger? Good for the bankers and their piles of cash, not so good for anybody else. If you have more debt than cash, or, if you have anything other than cash that you use as a store of value (except MAYBE PMs), this is going to hurt. If this was the first increase in a series of increases, get ready for all hell to break loose.

  9. Mr.E. says:

    I don’t think the action of increasing the discount rate – which is a reflection on the Fed’s perspective on member banks health and NOT monetary policy – surprises anyone who was awake. Bernanke’s prepared testimony for Congress told us last week that this was coming, and the bond market has been steadily falling in long anticipation of a lasting higher interest rate cycle. What is a surprise is that it was done between FOMC meetings, which is highly unusual and suggests a bit more than strongly is that there is a pressing concern.

    As one of the “millions hyperactive, adrenal-charged traders” who makes a living using BR’s “noise” I’ll be watching for a knee jerk to create a short-term opportunity. I will, however, become concerned if the initial knee jerk evolves into something consistent with a broad and more enduring change in the markets that I haven’t anticipated.

  10. The Window Washer says:

    • Inevitable ending of extraordinary accomodation;

    A pragmatic jabbing the bear in the eye with a stick.

    Ben wants to see what the reaction is, we all know the big progam changes are coming.

    I”m in the camp of people that think they will have to restart some progams before the end of the year, which means I’m wrong and it will be early Q2 11, but I would like to see them shock special interests as they turn off their program so they can see which ones matter.

    I’ll eat a bit of crow, I didn’t think Ben could pull off a “suprise” change but they did.

    Lets face it we knew it was coming but most of us thought a couple months more and in this situation 6 weeks early makes a market shock.

    Yeah Yeah Yeah treasury auction, bid to cover blah blah blah everyone has has been talkin that for 6 months. What was it last Sept when the bid to cover took a move down? Just like this week.

    This is funny because I just listened to a interview about how The Span would go around the vote in the early 90′s and change the discount rate when he didn’t have the votes for a funds rate change.

    Interview with former fed economist
    10-15min section of this ineterview,

  11. By surprise, I am referring to a raise in the DR on 2|19|10 @ 4:30pm.

    We all knew these would be going higher — I do not think that ANYONE here expected it yesterday.

  12. PS: Don’t be a pedantic arse.

  13. cognos says:

    Fed changes obscure (even un-used?) rate by tiny amount… here it comes!

    Or NOT — SPX futures basically back (off 60 bps) and 2yr USTs back (in 2bps from yest close, in 5 bps from overnight wides).

    Timing was odd.

    Maybe some large bank was actually starting to ask for large 28 day funding at the old rate (like a good economic game as the environment improved) and the Fed needed to shut it down… and say… “go pay LIBOR”… which is 23 bps on 1L?

  14. Thalamus says:

    I predict the market will be volatile today but ultimately close higher–too many think this is bad news. We need to get rates (or the banks cost of funds) up to a fair level so those who lend it to banks (depositors) can get a fair return. How many retirees living on CD’s are hurting right now? The banks live off their cheap money. Sure the economy can’t survive high rates with many homeowners underwater and trending down, but the day of reckoning is a good thing and will be positive in the long run.

  15. Mr.E. says:

    The knee jerk seems to have quieted ahead of major stock exchanges opening bell,trading right in the middle of the trading range before the break late yesterday of the previous two days, and the CPI numbers are being received favorably in pre market action with prices moving back to the top of that range. Clearly, inflation is not an immediate concern.

    Just a SWAG, but my suspicion runs along the lines that this was meant to be a salvo over the bows of member banks to get and keep their reserves in order. That leads me to wonder if the Fed is either suspecting or concerned about unusual action in the bond markets?

  16. ironman says:

    With this kind of news-driven market noise event, you can expect most of the negative market reaction related to this event to play out (and peter out) in the morning hours, with the biggest move being the gap down at the open (which the stock futures already anticipate.) I would anticipate the market behaving similarly to how it acted back on 20 January 2010.

    The thing to be concerned about is an additional unanticipated news-driven noise event, like what happened on 21 January 2010.

  17. cognos says:

    torrie — the way to have lower oil prices is NOT to kill the economy with rates (why? such a blunt instrument). high oil prices are their own solution… $100/bbl or $150/bbl oil… will eventualy result in $25/bbl oil through new technology and consumer choices.

    But the opposite is also true… $25/bbl oil will result in very little energy tech research and lots of SUV buying (see 1990s). We are now moving fast to other sources of energy which have the potential to dwarf oil (solar, wind, nuclear, even nuc fusion, geo-thermal). With 100-yrs of focused research, each of these has the potential to make oil looks like a silly by-gone age.

    The Fed should ignore oil.

  18. cognos says:

    … and really all commodity prices. (Commodity prices are volatile, but they solve themselves through supply/demand balance driven by the price. They have not been (30 yrs!) any sustained source of inflation.)

  19. bonghiteric says:

    The fed dropped the rate .75 due to the actions of one rogue trader, Kerviel. It seems logical that they raise it now by at least that much.

  20. Mike in Nola says:

    cognos: problem with commodities is that the speculators have been ignoring supply/demand for about 8 months now. No increased demand, but prices higher.

  21. wally says:

    “guessing as to the motivations”

    It is a signal – a very small one – and the market will shrug it off because it does not want to think about such things.

  22. [...] What can the Market tell us about Surprise FED Action? – The Big Picture [...]

  23. VennData says:

    Bernanke hiked rates to calm the excitement of Tiger’s return…

    …thereby dampening expectations in the Country Club Republicans who see the shamed star as an alternative to Sarah Palin and her sober, Austrian-Economics-based claims of black men destroying the dollar…

    …Sarah Palin’s claims came just at the dollar’s low point for this cycle, possibly a generation. I eagerly await her next economic prognostication.

  24. torrie-amos says:


    your a hedge fund, so price is the final arbitor, and you use opm, in the real world with your own money profit is the final arbitor, if you can’t figure out input costs you can’t budget shyte

    they talk talk talk, oh small bizz small bizz, well, unless it’s some small inet, you can’t estimate costs safely unless you have some huge huge huge bankroll and long term plan, which 80% of small bizz do not

    oil is a tax on all, at 140 a barrell, it cost 5k more a year in gasoline for each family, choice, work gas, or mortgage, we know what happened

  25. The Curmudgeon says:

    Could Uncle Ben be worried about the price of rice (and other commodities)? Wholesale prices, or producer prices, not excluding food and energy since, really now–does anybody not need to eat and stay warm?–are up 4.6% year over year.

    But that’d probably be giving them way more credit than they are due–i.e., to see in the producer prices what they refuse to see in the CPI.

  26. Invictus says:

    Bernanke, February 10 testimony:

    “Also, before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate. 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 signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC.”

    Good grief, could he have signaled this any more clearly?

  27. flipspiceland says:

    As confirmation, been long TBT expecting a rise AT ANY TIME. Including EVERY DAY. Pedantic, my ass.

  28. cognos says:

    torrie — 5k more each family. wow. that family might need to lower their gas usage. $5k @ 2.50 (extra per gallon) = 2,000 gallons of gas. At 25 mpg… that family is driving 50,000 miles per year. Or about 200 miles per day.

    The cost of “gas” is over-stated. At present oil prices it represents somewhere around 10-20% of the total-cost-of-ownership of a mid-sized $30k car. Over 5-yrs this car costs say $50k in price + insurance + maint + gas + misc. “Fuel” represents… say 15% of that cost. So were gas prices to double… the price of “family transportation” increases to 115%.

    (Which is why our regular economy was doing fine even when was oil was >100. What happened was the Fed was too tight. Should’ve been 0% as soon as Bear went bankrupt… and probably 2% back in Aug 07 when it was apparent the AAA credit markets were broken. But they were worried about oil and commodities… which then crashed >50% to close to 30-yr lows. Price indexes still read “deflation” since July 2008. Commodities are volatile but not important for the broader economy.).

  29. Marshall says:

    That’s certainly their concern, although I think the only area where they can legitimately lose control is the external value of the currency. If the Treasury only issues short-term debt, its interest rate will be determined by substitution in the overnight lending market—in other words, the rate on Treasury debt will be set relative to the Fed’s overnight target rate. This result holds no matter how big the deficit or how much government debt is issued—so long as its maturity is short enough that it is a close substitute for overnight interbank lending. This means that the government doesn’t need to allow the markets to determine the interest rate it pays on its debt. And even if it chose to issue longer-term bonds, Fed could actually set interest rates of different maturities if it were willing to deal in bonds of different maturities. Effectively, government would offer the equivalent of a range of “certificates of deposit” with different times to maturity at different interests—exactly what banks do with their CDs. If it offered, say, 4% on “deposits” of 30 years but found no takers, that would be perfectly fine. It could either adjust the 30 year rate to try to find buyers, or, better, simply let buyers choose shorter maturities at lower rates. And, by the way, public debt would actually go down in this scenario, at least in an accounting sense.

    Foreign sellers of goods, services, or assets to the US receive dollar credits—usually to a foreign branch of a US bank or to a correspondent bank. Their bank receives a credit to its reserve account (or, to the reserve account of their “mother” bank). If this bank prefers domestic currency reserves, the dollar reserves can end up in the account of the central bank. In any case, the holder of reserves will probably try to find a higher interest rate—offering reserves in the overnight market, or buying US treasuries. All of the analysis presented in the previous paragraphs applies, with one wrinkle. The foreign holder could decide to exchange the dollar reserves for other currencies. Of course, the exchange cannot occur unless there is someone with the desired currency willing to exchange for dollars. It is conceivable that as portfolios of currency reserves are adjusted, exchange rates would adjust, and, hence, the US current account deficit could place downward pressure on the dollar. While the conventional wisdom is that by raising domestic interest rates the Fed could keep the dollar from depreciating—although there is plenty of empirical evidence to doubt the efficacy of interest rate adjustments with regard to impacting exchange rates. But I think the decision to sell products to the US is not independent of the decision to accumulate foreign currency. I’m skeptical of the repeated claims that the interest rate paid on foreign currency reserves is as important as the decision to export or to accumulate foreign currency. Holders will, of course, try to earn the maximum return consistent with their appetite for risk—hence, prefer government bonds that pay more than reserve deposits at the central bank. But they will take what they can get.

    I know, I know, I’m being complacent (or so I’m told). But I’m still waiting for a cogent explanation of how the Fed actually “loses control” of the bond market.

  30. Andrew says:

    Speaking of which. Apparently they’re still long a good amount of Treasuries…

    Pimco’s Gross: Fed move is not start of tightening cycle

    “I don’t think it’s the beginning, really, of a tightening from the standpoint of monetary policy,” Gross told Reuters Insider television soonafter the Fed’s decision. “I don’t think it is the beginning of an increase in the fed-funds rate or in terms of interest on reserves that has been discussed as well.

  31. Marshall says:

    All depends what Treasury does. And by the way, the discretionary spending that is supposedly “out of control” is actually not that high. The largest portion of the increase in the deficit has come from automatic stabilizers and not from discretionary spending, which is a reflection of our lousy economy.
    As estimated by the New York Times, even if we were to eliminate welfare payments, Medicaid, Medicare, military spending, earmarks, social security payments, and all programs except for entitlements, and in addition stopped the stimulus injections, shut down the education department, got rid of a number of other things and doubled corporate taxes on top of all of this, the budget deficit would still be over 400 billion. This further demonstrates the non-discretionary nature of the budget deficit. And of course this doesn’t take into consideration how much more tax revenues would fall and transfer payments would rise if these cuts were to be undertaken. With the current automatic stabilizers in place, the budget cannot be balanced, and attempts to do so will only cause damage to the real economy as incomes and employment fall.

    As Abba Lerner once wrote, fiscal policy should be conducted with view to results and not following some conventional/ceremonial ideas about what is sound and what is not.

  32. Bokolis says:

    This was too telegraphed, as has been pointed out, to be the messing-with-Sasquatch or artificial momentum generator that it could have been used to be.

    Bokolis’ initial reaction was, whotheF cares? If the lack of traffic on my drive to work this morning is any indication, not many of you care, either. Judging from the volume, even the shlubs that would maneuver on an expiration Friday don’t care.

  33. cognos says:

    Marshall — your numbers are WRONG:

    Defense = $700B
    Social Security = $700B
    Medicare/Medicaid = $700B

    Together these 3 are roughly 2/3 of the federal budget and 2x the “deficit”.

    The typical point is the OPPOSITE of what you said… which is “descretionary” spending only affects 1/3 of the budget (and <1/3 without all this 'stimulus' spending).

    The typical point is that UNLESS one is going to talk about cutting defense, SS, or medicare… you arent going to shrink the govt much.


  34. d4winds says:

    This a non-event; but that doesn’t mean the markets won’t think so. Absolutely nothing has been done by the Fed to increase the rate it pays commercial banks for excess reserves (circa $1tn+ for the last year). That rate–much more important now than Fed Funds ever was–is the governor on the bank money creation process. So the Fed’s deeds have entirely matched their words on QE. Also, cash-for-trash and Ibank support at the discount window has not ended. The only signal being sent by the Fed is that it thinks that private credit markets are–finally–on the mend. As for traders pay attention to, mainly it’s to what other traders are doing.

  35. This tightening move is a mistake, but it is a reversible mistake. And perhaps this is the price Bernanke has paid to keep fed funds rate at near zero longer.

  36. rashley314 says:

    Just coincidence that it comes on the heels of the Taibbi article talking about borrowing from the Govt and buying bonds??? Nah… too Oliver Stone-ish…

  37. torrie-amos says:


    average family 2 peeps, 20 gallons per driver, that’s 40 total per family, 40 times extra 2 bucks = 80 times 52 = 4160 after taxes, pre tax over 5k

    gas started decade out at 1.50 avg, boil dem frogs

    avg cars on road, get’s no where near 25 mpgs, hell i got a honda i get 18-20 real life, so at 20 mpgs per gallong

    average on a spread sheet versus real life is quite different, maintenance, who needs maintenance, that gets put off and it escalates

    you do realize 80% of people do not think like you?

  38. Pat G. says:

    Zilch!! They raised the discount rate at the “window” a quarter of one percent. Who cares when as it was way overdue. The ass clowns on CNBC are touting this like the FED is beginning to tighten. Please.. No wonder serious journalists there are abandoning that drowning ship like rats. In either event, gold took that and the news that the IMF is selling 190 metric tons of the metal into the open market in stride. The Canadian dollar actually stregthened against the USD. Forget the Euro, as we both have the same sort of problems. Compare the USD to a country who has its fiscal shit together.

  39. [...] the media and the markets. Pundits discuss earnestly the spice has been added to the tea leaves. Barry Ritholtz lists three possible motivations behind the Fed’s [...]