Raymond James’ Dr. Brown: Reading into the rate hike

The following is a daily market commentary by Scott J. Brown, chief economist and senior vice president of equity research at Raymond James & Associates Inc.

Thursday: After the close, the Fed’s Board of Governors raised the discount rate. This is not a tightening of credit.

Last week, Bernanke testified that the discount rate (the rate the Fed charges banks for short-term borrowing) would be raised “before long.”

Well, that didn’t take much time. In its policy statement (and as emphasized by Bernanke last week), the Fed’s Board of Governors indicated that this is part of a normalization process (the spread between the discount rate and the federal funds rate target was 100 basis points before the financial crisis).

The Fed extended the maturity of loans made from the discount window during the crisis. It has now returned the terms to overnight. The timing of the discount rate hike was a surprise, and some may think that the Fed is getting closer to tightening credit. However, the Fed indicated that “these 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, which remains about as it was at the January FOMC meeting.”

The early economic data were a bit disappointing, but the midmorning figures were in line with expectations.
Jobless claims surprised to the upside last week. A Labor Department spokesperson did not comment on the impact of the weather. Four states were estimated, including California (which leaves open the possibility of revisions).

The Producer Price Index rose more than expected in January, boosted largely by higher energy prices (gasoline up 11.5%). Exfood & energy, the PPI also rose more than anticipated. However, the increase does not appear to be a major threat to the outlook for inflation at the consumer level.

The February Philly Fed figures were consistent with moderate growth in that region’s manufacturing sector. New orders advanced at a more rapid pace. Employment continued to expand. Input price pressures remained moderately high, but firms still had little success in raising prices of finished goods. Firms were somewhat less optimistic about the next six months, but capital spending plans improved.

The LEI posted its 10th consecutive monthly increase in January. However, components were more mixed than in previous months (consistent with a moderate economic recovery).

Today: Equity futures dipped following the Fed’s discount rate announcement. Let’s see how the markets digest the news. The report on the Consumer Price Index tends to have few surprises (especially relative to the more volatile PPI).

Higher gasoline prices are expected to propel the CPI higher in January. Energy prices are significantly higher than a year ago. The housing sector’s troubles have put downward pressure on rents, resulting in relatively mild increases in core inflation.
Next week, Fed Chairman Bernanke will deliver his semiannual monetary policy testimony to the House Financial Services Committee on Wednesday (10 a.m.) and to the Senate Banking Committee on Thursday (9 a.m., same written commentary, but new Q&A). Most likely, Bernanke will continue to expand on the Fed’s exit strategies (and further explain the hike in the discount rate).

Remember, he’ll be presenting the views of the entire Federal Open Market Committee, not just his own. The key economic releases will be on consumer confidence (Tuesday), durable goods orders and jobless claims (Thursday), and the first revision to 4Q09 GDP growth (Friday). Bernanke’s testimony may not provide the best background for incoming Treasury supply (30-year TIPS, 2-, 5-, and 7-year notes).

For more commentaries by Dr. Brown, go to rjcapitalmarkets.com/eco_commentary_240_main.asp.

Related Topics: Raymond James & Associates Inc.