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How Unexpected Was Cutting The Discount Rate?

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All the newswires are describing this morning’s action by the Federal reserve as a “surprise.” It was certainly unusual. For the past several years, the discount rate—which is the only interest rate the Fed actually sets—has been set exactly 100 basis points above the targeted Fed Funds rate. This morning’s move signals a willingness to use the discount rate as a Fed policy tool.
But it was not exactly surprising to many who had been listening closely to the chatter in the markets all week. Many traders were predicting some rate cut, even though they had the details wrong. Most expected an emergency cut in the Fed Funds target rate to come yesterday. But there had also been talk since Wednesday evening that the Federal Reserve had ‘all of its tools on the table’ and might make some unusual move beyond liquidity injections but short of lower the target rate.
And, in fact, many felt that opening the discount window might be exactly the move the Fed might take. On Wendesday night, CNBC economics reporter Steve Leisman told Melissa Francis that “all options are on the table” at the Fed. When asked for specifics, Leisman hit on a number of possible policy tools but the first one he mentioned was the discount window.
“The Fed has a variety of tools that it is able to use,” Leisman said. “It has a discount window and it has a rate, at which banks can come with almost any collateral and they can borrow . That rate is now 100 basis points higher than the Fed funds rate. It’s six and a quarter percent. The Fed could lower that. That’s one thing they can do.”
Of course, Leisman went on to run through the list of more typical Fed moves. But this might have been the first time someone had indicated the possibility of a cut in the discount rate in such a public forum.
So did people know, suspect or somehow intuit the Fed move? Some are saying that yesterday’s volatility may have been due, in part, to the widespread expectations that the Fed would take some action during the day or the following day. Many market participants have described the end of the day rally as shorts covering in anticipation of Fed action on Friday. So perhaps the Fed move wasn’t quite as unexpected as much of the coverage implies.
All Options on Fed's Table [CNBC]