By Steven K. Beckner

(MNI) – Despite rife speculation to the contrary, a Monday meeting
of the Federal Reserve Board of Governors is unlikely to yield another
hike in the discount rate or a further widening of the spread between
the penalty at which banks borrow from the Fed and the federal funds
rate.

Indeed, there is no guarantee that the Fed will widen the spread
any time in the foreseeable future.

When the Fed’s policymaking Federal Open Market Committee
eventually raises the federal funds rate and the interest it pays on
excess reserves (IOER), the Board will presumably increase the discount
rate more or less automatically in tandem just to preserve the
prevailing spread. But that may not happen until sometime next year.

In the meantime, there is no apparent consensus on the need to
widen the spread from the current 50 basis points back toward the
pre-crisis 100 basis points.

On Feb. 18, at the request of the 12 Federal Reserve Banks, the
Board of Governors raised the primary credit or discount rate from 50
basis points to 75 basis points, thereby widening the spread between the
discount rate and the federal funds rate from 25 basis points to 50
basis points. It simultaneously voted to further reduce the maturity of
discount window loans from 28 days to overnight.

The action came eight days after Fed Chairman Ben Bernanke
signalled an impending discount rate hike by telling the House Financial
Services Committee one was coming “before long.”

The Feb. 18 discount rate hike was justified on the basis of
“continued improvement in financial market conditions.”

A few banks had been relying more heavily on the discount window
than the Fed would have liked, and the rate was increased in part to
encourage banks to rely more upon borrowing from each other than from
the Fed.

However, less than two months later, as the Board holds a routine
meeting to consider discount rate requests from the Federal Reserve
Banks, the situation is different.

Bernanke has not signaled that another discount rate hike is
coming, and Fed officials have given no indication they see a need for a
further widening of the spread to discourage excessive borrowing from
the window or to encourage inter-bank borrowing.

In the week ended April 1, primary credit lending averaged $7.6
billion, and while that was up from just over $3 billion in the prior
period, it was down from more than $52 billion a year earlier.

From what Market News International understands, there is no
preconceived plan or notion that the Fed needs to get the spread back to
100 basis points — or even to widen it from 50 basis points to 75 basis
points.

When the Fed changed its discount window policies in January 2003
to make the “primary credit” a penalty rate, it initially set it at 100
basis points above the federal funds rate. (It had previously been set
below the funds rate).

That 100 basis point spread prevailed until the onset of the crisis
in late summer of 2007.

On Aug. 17, 2008, “to promote the restoration of orderly conditions
in financial markets,” the Federal Reserve Board lowered the primary
credit rate, at which depository institutions borrow short-term from the
Federal Reserve Banks, by 50 basis points to 5.75%. Since the federal
funds rate at that time remained at 5.25%, the spread between the two
rates was narrowed to 50 basis points.

At the same time, the Fed relaxed its usual procedures to extend
primary credit loans for as long as 30 days, renewable by the borrower.

The Fed said then “these changes will remain in place until the
Federal Reserve determines that market liquidity has improved
materially.”

As the crisis continued to deepen, the Board went further. On March
16, 2008, at the same time it authorized the New York Fed to begin
lending to primary dealers, it narrowed the spread between the discount
rate and the federal funds rate further to 25 basis points. What’s more,
it increased the maximum maturity of primary credit loans from 30 days
to 90 days.

As financial conditions continue to normalize, it is conceivable
that the Fed could at some point nudge the spread wider, but there is no
immediate pressure to do so at this time. And in fact, the Fed may be
content to leave the spread at 50 basis points indefinitely.

** Market News International **

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