Rama Krishna Vadlamudi February 20
On February 18
, the US Fed has given a mild surprise to the financial markets by raising the discount rate by 25 basis points from 0.50 per cent to 0.75 per cent. This is the first major move by the US Fed as part of its exit strategy.Reacting strongly to the Fed move, the US dollar has rallied against the Euro and Pound Sterling. The dollar hit a nine-month high against euro with the euro quoting at 1.35 on Friday. The Euro’s recent high was 1.50 against the US dollar in December 2009. The dollar rallied against the Japanese Yen and pound sterling also – the Yen weakened up to 92 while the pound depreciated to a level of 1.55 against the dollar. The stock markets reacted negatively to the discount rate hike and major indices across, the US, Europe and Asia-Pacific witnessed cuts in the range of one to two per cent on Friday.While raising the discount rate, the Fed has indicated that this is a not a signal for modifications in the outlook for the economy or the monetary policy. Several policymakers does not want to dub this as a withdrawal of stimulus, rather they would love to call it as a “normalization process,” a new word they designed for their latest actions as these financial systems seem to have come out of the crisis situation.
What inferences can be drawn from the hike in Discount Rate?
1. It seems to be the end of cheap money. Till now, investors used to resort todollar carry trade by borrowing from the US market at zero or near zerointerest rates and invest in commodities or stock markets of emergingeconomies. This is the serious beginning of an exit strategy from the Fed.2. There is a marked upturn, however fragile it may be, in the US economy andas such the US Federal Reserve is more confident about the sustainability ofUS recovery in the next three to four quarters3. However, Ben Bernanke, the US Fed Chairman, has stated that the interestrates will remain “exceptionally low” for “an extended period of time.” It meansthat the Fed may not raise the all-important benchmark Federal Funds Rate