Comparing The Fed Funds Rate With The Primary Credit (Discount) Rate Over The Past Decade

Tyler Durden's picture

Much has been said about the 25 basis point Discount Rate rate hike announced on Thursday. Some suggest that this was fully expected, priced in, and that to the Fed this is merely a technicality which will not impact the Fed Funds rate in the least. Others, such as Macro-Man, take a decidedly more pragmatic approach, and ask the simple question: if it really means nothing, why do it? "He" also goes on to suggest some possible trade ideas as a result of this action: we suggest checking out his post for further information.

Instead of speculating what the Fed may or may not do (we doubt even the Fed knows - as Krugman points out, the Fed's action could be a function simply of what political party is currently in charge), we have decided to show a simple comparison of the Discount Rate and the Fed Fund rate over the past 10 years (chart below). A few things jump out: before the crisis started in 2007, the spread between the Fed funds target rate (5.25%) and the primary credit, aka discount rate, which was a 6.25%, was 100 bps. The first notable action that the Fed did vis-a-vis the discount rate was to cut it by 50 bps to 5.25% on the morning of August 17, 2007 (in the heyday of the quant implosion when the market was gyrating like a drunken sailor courtesy of busted quant models at GS Alpha and other core quant shops). The spread was subsequently cut to 25 bps on March 16, 2008, when Bear was unceremoniously handed over to JP Morgan for pennies on the dollar. It remained there until Thursday, when it has again moved to 50 bps.

Looking at the chart demonstrates that there has been not one period over the past decade when there was a substantial widening divergence ever since January 9, 2003, when the current discount rate system (primary, secondary) took over the old system in which adjustment credit, extended credit and seasonal credit were the primary forms of crediting available to depository institutions (which in itself is of course an anachronism - only some of the current Discount Window institutions are, in fact, depository institutions, but that is the topic of another rant). We encourage readers to take a look at 12 C.F.R. Part 201 and Part 204, which was the final ruling for conversion to the current discount rate system, it is a rather interesting analysis (not to mention the fact that prior to 2003, the discount rate was inside the Fed Funds rate, thereby allowing banks to arb the Fed once again, only in a different manner). But in summation, any increase in the primary credit rate has always been followed in parallel, or shortly thereafter, by an increase in the fed funds rate. Just how different will this time be?

As Stone McCarty points out "It is also probably not an accident that the announcement of tomorrow's discount rate hike (and next month's shortening of loan maturities) comes just after the release of the January 26-27 FOMC minutes. The discussion in those minutes further serves to underscore the technical, as opposed to policy, nature of today's move." Yet we think that there is more to this, as the Fed will sooner or later be forced to come face to face with a broken monetary system, in which it stands to lose all control should it not tighten in advance of a potential monetary supply explosion which would lead not only to hyperinflation (should the Fed gets its way, and consumers finally start borrowing), but also to full loss of the Fed's control over the American monetary system. Keep a close eye on this chart: we are confident that the Fed Funds will be hiked before there is another unsymmetrical increase in the discount rate. Alas, the economy is far too weak to sustain a tightening posture at this point. As to what kind of aberrations in the market this action could lead to, we will investigate in the coming days and weeks.

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order6102's picture

i think FED main goal at the moment to make sure there are no easy money flowing to banks, so banks can focus on their core activity: lending to consumers and SME. Next step will be negative rates on CA. They need to get velocity of money back in economy: from M0 to M3... 

Anonymous's picture

If they are trying to inflate and also increase money velocity, they should be INCREASING the Fed Funds rate, and giving savers some money to play with.

Zero Interest Rate Policies GUARANTEE deflation and stagnant money.

Additionally, the nasty downside for the IRS and US Treasury of zero rate policies will be hitting full force this year at tax time (actually not hitting might be a better way to put it). The amount of taxable interest and dividends has slowed to barely a drip, and taxpayers simply owe the IRS practically nothing in this column anymore.

Anonymous's picture

"The amount of taxable interest and dividends has slowed to barely a drip, and taxpayers simply owe the IRS practically nothing in this column anymore." So true,this situation may last for another 2-3 years. The deflation force is so strong, no end yet.

JR's picture

I would like you to explain what “the amount of taxable interest and dividends slowed to barely a drip” has to do with deflation? Did prices on nondiscretionaries go to negative along with the interest rate that Bernanke is using to wipe out savers--because he doesn’t need savers’ money for reinvestment purposes anymore?  Because he just prints whatever the international bankers order?  No!  Prices did not!  Deflation is the Fed’s ruse to continue its transfer of Americans’ meager wealth to the banking cartel.

I talked yesterday with a retired building contractor, 70 something—an old pro now doing odd handyman jobs when he finds them.  Two years ago, he had sold a five-unit rental he had built several years back because, being in California, it was continually being broken into; at the same time, he pulled his IRA money out of the stock market and reinvested it in CDs, now earning abut 1.65%. This is the nest egg, plus SS, that he and his wife have to live on, trapped in a financial box canyon deliberately set up by the Fed and the Congress.   He is still working, doing small jobs by himself, when the arthritis in his hands allows him.

And he said to me, I’m now afraid, if I live very long, I won’t have enough money to live on.

Tell this hardworking father of three all about the Bernanke deflation myth.  Tell him that his representatives in Congress will put a stop to this blood-sucking banking cartel that is running and raping this country and everyone worth his salt that’s trapped in it.  Better yet, just laugh at him and call him an ignorant, profligate baby boomer who caused this mess  “living beyond his means,” abusing his credit card and using his home equity as an ATM. Tell him all about the "deflation force."  That should take care of him.

No wonder the Blankfeins and the JP Morgans get by with financial murder.

When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing - when you see that money is flowing to those who deal, not in goods, but in favors - when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you - when you see corruption being rewarded and honesty becoming a self-sacrifice - you may know that your society is doomed.-- SWRichmond   

Tethys's picture

That quote from Ayn Rand's book 'Atlas Shrugged' really deserves a little more context.  Basically her answer to those who claim that 'money is the root of all evil'. Seems quite relevant today:

 

"Do you wish to know whether that day is coming? Watch money. Money is the barometer of a society's virtue. When you see that trading is done, not by consent, but by compulsion--when you see that in order to produce, you need to obtain permission from men who produce nothing--when you see that money is flowing to those who deal, not in goods, but in favors--when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you--when you see corruption being rewarded and honesty becoming a self-sacrifice--you may know that your society is doomed. Money is so noble a medium that is does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot.

"Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, 'Account overdrawn.'

"When you have made evil the means of survival, do not expect men to remain good. Do not expect them to stay moral and lose their lives for the purpose of becoming the fodder of the immoral. Do not expect them to produce, when production is punished and looting rewarded. Do not ask, 'Who is destroying the world? You are.

"You stand in the midst of the greatest achievements of the greatest productive civilization and you wonder why it's crumbling around you, while you're damning its life-blood--money. You look upon money as the savages did before you, and you wonder why the jungle is creeping back to the edge of your cities. Throughout men's history, money was always seized by looters of one brand or another, whose names changed, but whose method remained the same: to seize wealth by force and to keep the producers bound, demeaned, defamed, deprived of honor. That phrase about the evil of money, which you mouth with such righteous recklessness, comes from a time when wealth was produced by the labor of slaves--slaves who repeated the motions once discovered by somebody's mind and left unimproved for centuries. So long as production was ruled by force, and wealth was obtained by conquest, there was little to conquer, Yet through all the centuries of stagnation and starvation, men exalted the looters, as aristocrats of the sword, as aristocrats of birth, as aristocrats of the bureau, and despised the producers, as slaves, as traders, as shopkeepers--as industrialists.

"To the glory of mankind, there was, for the first and only time in history, a country of money--and I have no higher, more reverent tribute to pay to America, for this means: a country of reason, justice, freedom, production, achievement. For the first time, man's mind and money were set free, and there were no fortunes-by-conquest, but only fortunes-by-work, and instead of swordsmen and slaves, there appeared the real maker of wealth, the greatest worker, the highest type of human being--the self-made man--the American industrialist.

 

JR's picture

Thank you. Powerful, and now, quite sad.   And my apologies to the great SWRichmond for my ignorance, while still acknowledging both his and your knowledge of Ayn Rand and the importance of this quote to America’s financial history.

I am a Man I am Forty's picture

Wow, smart chick.  That last paragraph doesn't quite fit anymore.

Hephasteus's picture

The relative size of M0 to M3 is too large. There will never be any velocity without destroying M3 or increasing M0 several times.

Think of it like a bournelli effect. When you run a fractional reserve system you create a horn like structure that goes long and straight for a while then starts exponentially climbing or horns out at the end. The money flowing through the horn starts at high velocity and it's velocity decreases as it gets further out on the horn. All the off balance sheet stuff that's been going on for years was just a way to artificially make the horn tighten up enough to keep velocity up.

The cash flow has stalled. The fart coming out the end is silent but deadly. You can't increase velocity back up till you have credit destruction and forgiveness. Banks never forgive since they figure out how to simply put it all in a central location and turn the toxic loans into tax payer liabilities.

Oh by the way. Where's Order at. Did you guys fire him or send him back to troll with the retards someplace else.

Anonymous's picture

Bernoulli ...

Do you hear that great sucking sound?

Ruth's picture

The Board also proposed that primary credit be available for periods of up to a few weeks to generally sound institutions that cannot reasonably obtain such funding in the market. The Board proposed no restrictions on the purposes for which the borrower could use primary credit. The proposal contemplated that Reserve Banks would establish a System-wide set of criteria, based on supervisory and other relevant information, which would be used to determine whether an institution was in generally sound financial condition and thus eligible for primary credit. The Board proposed that primary credit normally be available at a rate above the target federal funds rate of the Federal Open Market Committee (FOMC) and that the initial primary credit rate be 100 basis points above the target federal funds rate.

...is that where we got our subprime underwriting guidelines?!

Anonymous's picture

Or they could carry out the tried and true false flags

http://www.nakedcapitalism.com/2010/02/guest-post-governments-from-aroun...

spekulatn's picture

Vic Niederhoffer on the discount rate,

"Amazingly, since the beginning of the Fed 100 years ago, there have been very few reversals in direction of the discount rate. About 25 in the last 100 years. The average run of changes in the same direction is about six."

http://www.dailyspeculations.com/wordpress/?p=4436

Anonymous's picture

"Yet we think that there is more to this, as the Fed will sooner or later be forced to come face to face with a broken monetary system,"
---------------

Where are you going? Why don't you walk the wheel with us? What is the matter my American friend? What has upset you? Oh! I know. The bad machine doesn't know that he's a bad machine. You still don't believe it. You still don't believe you're a bad machine? To know yourself is to know God, my friend. The factory knows, that's why they put you here. You'll see... You'll find out... In time, you'll know.

http://www.youtube.com/watch?v=LlXABsfDdBc&feature=related

JJP's picture

"This video contains content from Sony Music Entertainment, who has blocked it in your country on copyright grounds"

 

:-(

Anonymous's picture

To anon 239033:

If you understood English, you would realize he is talking about the FED and its perspective.

Before you peddle your anti-American gibberish, get a grammar book.

Anonymous's picture

This is once again a bullshit move by the Fed. A Great big Nothing Burger. Until they change the Feds fund rate, This is nothing, Shit, Nada. Bernanke assured congress that the FEDS FUND RATE will not be touched. Im sure China knows this already.

Lionhead's picture

Since the T-bill market always leads the FED funds rate, I'm watching T-bill rates & the 2-10yr spread. The market will signal the FED when to move as it historically has. Watch the market, not the FED or their minions or gurus. Waste of time...

http://tinyurl.com/yhqewcf

order6102's picture

why you don't just look at ED$ and FF futures. give you much better idea then anything else.

 

Anonymous's picture

Ugh, yet another weak article, thanks to the last part-- "Yet we think that there is more to this, as the Fed will sooner or later be forced to come face to face with a broken monetary system, in which it stands to lose all control should it not tighten in advance of a potential monetary supply explosion which would lead not only to hyperinflation (should the Fed gets its way, and consumers finally start borrowing), but also to full loss of the Fed's control over the American monetary system."

blah blah blah....

If they provide attractive enough interest rates for reserves on deposit at the Fed, none of the reserves banks are holding will ever be lent out. They just added this reserves interest rate recently.

Further, there are few credit-worthy borrowers worth lending to, and accordingly, banks have been withholding loans. So the Fed's reserves interest rate hasn't even been needed yet.

Anonymous's picture

The Fed chases the 3M T (always)

Anyone who says otherwise is not worth his weight...

The FED does not declare the rate at which institutions borrow. That rate is, and always will be, determined by the free market.

The Fed can, and always will, rape the free market in any way it can.

Anyone who thinks they can argue this point can reach me at eromig@gmail.com

ozziindaus's picture

You're exactly right. The FED cannot take on the enormous size of the open bond market. If they try to outrun yields against the market, government debt holder will pack up and split. Same applies for the 10 year T note on the open market setting mortgage rates. IT"S NOT THE FED.

Anonymous's picture

What I get out of this from the 2003 Discount Rate hike: We may easily see a year and a half go by before we have an increase in the FFR, all other things being equal.

...so party on likes its, well, 2003!

Anonymous's picture

The Fed has boxed themselves into a corner. The only thing they can do is give the "appearance" of being hawkish. In reality, easy money will be there for some time to come.

If the Fed made the hard choice of raising all rates and truly undoing what they've done, the market would crash and the politicians would not get re-elected. It's not all about economics.

SDRII's picture

raise rates and do the right thing the markets would crash? maybe but the bigger issue (putting aside greenspan's contention that stocks going down is real wealth lost) arouond raising rates is exposing a gutted  economy which is a national security issue beyond Bernanke paygrade. The capacity of the sovereign to service its debts under such a scenario whereby you have no change to outlook other than an inability to fund the ongoing psyop campaign. The disco rate is about perception little else. Bernanke is fighting confidence which makes the Euro mishap convenient.  

Anonymous's picture

I don't care who's in charge of the pig pen, Just get the damned CD rates back to m4 or 5%

Hephasteus's picture

That would make m3 raise against m0. Which won't ever happen again. It's all the downside of a fractinonal reserve system without the upside and it will remain that way until enough people hold enough gold to make it stop.

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