The Federal Reserve banks requesting a hike in the Discount Rate increased from 4 to 5 according to the MInutes. What does it mean?
First a little background:
A long time ago, in a galaxy far far away the Discount Rate was lower than the prevailing Funds rate as the stigma of utilizing it was higher than the more logical penalty. The crisis exposed all the participants as Lepers, however, and adjusted the Discount to its proper penalty status.
Prior to our publication of "Trading the Turn" (Chapter 16 in the invaluable Eurodollar Futures and Options Handbook), we may or may not have (pick A) levered up large bets against the prevailing Turn Pressure fears and occasionally funded them with cheap small lots from the Fed. But back to the story.
So, 6 Reserve Banks maintain their vote for steady at .75%. The folks in Minnesota have been asking for a decrease !? And now 5 banks think the Rate should go to 1%. From a FRB FF target standpoint, this vote seems mild. Both the Dots and the rhetorical pathway paving would suggest a heavier tilt toward a higher Disco Rate. Thus, it is fair to wonder how the tool is viewed in the pecking order of blunt and signaling devices at the Fed's disposal. Are we to believe that most would prefer the FF to rise but not as many the Disco? Remember, these are supposed to be the "Hawks."
The recognized level of wholesale funding has conveniently gelled around he midpoint of the 0-.25 range for "Zirp." This indicates the actual penalty for Disco borrowing is closer to 62bp than the textbook 50. If the Funding rate is lifted, is the penalty hoped to maintain the present spread, increase or possibly tighten? And, under any situation, what would the implications for monetary policy be? Let's not forget that in this cycle the Fed will also be calibrating the intensity of the Death Star (Full allotment, fixed rate, overnight reverse repo facility--never gets old) in these structures.
So what do we know? Some of the FRB seats want to raise the Funds rate. Some, about half, the Reserve Banks want to raise the Disco. The adjustment would spotlight the end of the happy universally accepted structure known as "the lower bound." The revolution that is switching from a quantitative to rates regime commences at that moment. The people in charge are clearly fearful of this transition. We are one yellow brick closer to leaving Oz.