Fixed Income Weekly

The Fed took the market by a bit of a surprise after Thursday’s close when they moved the discount rate higher by 25 basis points to .75%, in addition to lowering the maximum term from 28 days to overnight. Before the crisis the spread between fed-funds and the discount rate stood at 1%, Thursday’s move brings the spread to about .65% if you use the current market fed-funds rate of 14 basis points. The reason for the 100 basis point spread during normal times is to penalize banks for going to the Federal Reserve for funding and encourage banks to get funding from other institutions through the fed-funds market. The spread was lowered in March of 2008 to lessen the strain on banks and provide a cheap source of liquidity for banks unable to obtain funding through fed-funds.

The short end sold off hard immediately after the release, gaining about 10 basis points in yield in the few hours following the announcement, but eased off the lows a bit in Friday’s trading. I don’t think that this move was meaningless, but it’s pretty close. The jump in rates was from the low end of the .8% to 1.1% range on the 2-year that we’ve been in for a while, and should expect to be in for at least the first half of 2010. As far as this move telegraphing an adjustment to the fed-funds rate goes, we still haven’t seen anything substantial from the Fed. Sure, Thomas Hoenig became the first dissenting vote last meeting when he urged to committee to remove the “extended period” language from the statement, but Thursday’s test will be followed by many more before a real move is made.


Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst