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Fed Cuts Discount Rate and U.S. Markets Respond

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The Federal Reserve Board cut the discount rate from 6.25% to 5.75% before the opening stock market bell on August 17. The Fed announced that it was taking this action in order to “promote the restoration of orderly conditions in financial markets,” after weeks of volatility in equity and bond markets in the U.S. and overseas.

Overnight, August 16-17, Japan’s Nikkei 225 had dropped 5.4%, or 874.81 points, to 15,273.68; and Hong Kong’s Hang Seng Index closed at 20,387.13, down 285.26 points, off 1.38%. Reaction on U.S. exchanges was swift, with the DJIA soaring in morning trading, at one moment up more than 300 points, and closing at 13,085.82, up 240.04.

Despite the U.S. markets’ euphoria, some experts are skeptical that the rate cut is good news. In an e-mailed HFE Notes to subscribers and journalists, High Frequency Economics’ Chief Economist Carl Weinberg, and Chief U.S. Economist Ian Shepherdson, pointed out that cutting the discount rate rather than the Fed Funds rate may indicate a serious complication to the liquidity crunch, the potential failure of an institution, “probably not a bank, but rather an institution that has substantial bank liabilities that may not be able to clear.”

On its Web site the Fed also announced “a change to the Reserve Banks’ usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially.” Typically, the discount window is used for very short, overnight loans.

The primary discount rate at the Fed is used to provide loans to “generally sound depository institutions that cannot obtain funding in the market on reasonable terms” according to The Federal Reserve Discount Window & Payments System Risk Web site.

For the full August 17 discount rate cut announcement please go to