Business | Economy
Fed unlikely to raise rates until markets stabilise
The Federal Reserve may hold off on its first interest-rate increase since 2006 until policy makers judge that financial markets are stable enough to allow the central bank to withdraw its lending backstop for Wall Street.
- Bloomberg
- Published: 00:07 July 9, 2008
Washington: The Federal Reserve may hold off on its first interest-rate increase since 2006 until policy makers judge that financial markets are stable enough to allow the central bank to withdraw its lending backstop for Wall Street.
Raising rates while at the same time removing securities dealers' access to direct loans from the central bank would be a double hit to markets that officials probably want to avoid, Fed watchers said. The Fed also may have a hard time justifying higher borrowing costs before it has a plan for ending emergency lending to nonbanks.
The timing difficulty, along with continued strains in credit markets, means traders may be mistaken in estimating the odds of a rate boost by year-end at 74 per cent.
"We think they'll wait until 2009,'' said Brian Sack, who used to head the Fed's monetary and financial market analysis group before he joined Macroeconomic Advisers as senior economist in Washington. Successfully dealing with an end to the Primary Dealer Credit Facility is "a hurdle for credit markets to get past before the Fed will likely start tightening,'' he said.
The Fed started the PDCF in March, invoking its powers under "unusual and exigent circumstances'' to forestall a collapse in confidence after the near-bankruptcy of Bear Stearns.
Emergency measures
New York Fed President Timothy Geithner, who spearheaded the central bank's rescue of Bear Stearns, said June 9 that the Fed's emergency measures would be in place as long as markets remained distressed. Persistent credit strains may leave officials unwilling to end the PDCF in September, after they said March 16 it would last for "at least'' six months.
Credit-default swaps on Lehman Brothers Holdings, Merrill Lynch & Co. and Morgan Stanley debt are trading close to their highest since March. The contracts let investors bet on the risk that a company will default on its bonds.
Another gauge of financial stress watched by the Fed has also remained elevated. The difference between the overnight indexed swap rate, a measure of what traders expect for the Fed's benchmark rate, and three-month interbank loans in dollars was 0.78 percentage point yesterday, about the same as the start of May.
In addition, commercial-bank loans outstanding have dropped to their lowest level since March, Fed statistics show. That will "put a severe stranglehold on economic growth,'' said former Fed governor Lyle Gramley.
Raising rates in such an environment "would be a very risky strategy,'' said Gramley, now senior economic adviser at Stanford Group in Washington. "I don't think they're going to do that, and I think markets have been premature in jumping to that conclusion.''
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