The Beginnings of Normalcy
In last week’s prepared testimony for the House Committee on Financial Services, Federal Reserve Chairman Bernanke spoke extensively on the gradual exit of the Federal Reserve from many of its emergency liquidity programs. At the beginning of February, several programs were allowed to expire, including the Primary Dealer Credit Facility (PDCF), the Term Securities Lending Facility (TSLF), the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), and the Commercial Paper Funding Facility (CPFF). Remaining programs, like the Term Auction Facility (TAF), are mostly set to expire in March. Because the liquidity crisis appears to be over, the Board also announced that it would increase the primary credit rate (often called the discount rate) by one-quarter of a percentage point to 0.75 percent. The announcement noted:
These changes are intended as a further normalization of the Federal Reserve’s lending facilities. The 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.
This statement matches the language used by Chairman Bernanke in his testimony, in which he said that any change in the discount rate “should be viewed as further normalization of the Federal Reserve’s lending facilities.”
Discount window lending has declined precipitously since the crisis that occurred at the end of 2008 and early 2009. Use of the Federal Reserve as a lender of last resort peaked in October 2008, immediately following the collapse of Lehman Brothers. Use of the TAF continued at elevated levels through the first half of 2009 but has recently fallen to levels not seen since the gap between the federal funds rate and the discount rate was 25 basis points higher. Given that the target range of the federal funds rate is 0–0.25 percent, the actions taken yesterday increased the spread between the two rates to 50–75 basis points.
Due to the communications of Chairman Bernanke and other Federal Reserve officials prior to the announcement yesterday, market reactions to the news were relatively subdued. There were slight increases in Treasury yields, but no more than 5 basis points. Pricing for fed funds futures saw a brief increase in volatility following the release but stabilized during Friday’s trading.