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The Change in the Discount Rate
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The Change in the Discount Rate

by MoleFebruary 18, 2010

Michael Davey/CD here…

You’re going to hear a lot of spin and frankly a lot of misguided remarks regarding the Fed’s change in the discount rate.

The noise, the noise – the noise!

Personally, I don’t give much credit as to whether or not this was anticipated or meaningless since the Fed is simply unwinding emergency measures from more drastic times with an instrument that banks rarely use anyhow. History is a much better guide than heads talking. In this case, history is relevant, but it will be the interest rate markets that will dictate how much and when.

Historically, a first increase in the Fed’s discount rate has little impact in and of itself, but stocks will be affected more or less according to the degree of change in the interest rate picture; in the months following.

Though it has not been re-edited since the 1990’s, Norman Fosback’s Stock Market Logic is a great source for studying bias in the market following a changing fundamental, such as a shift in interest rate policy. Here is Fosback’s summation regarding the stock market impact following an initial increase in the discount rate:

In the twelve months following increases in the discount rate, the stock market has also risen, but at a below average rate of less than 1% per quarter. Hence, a discount rate increase leads tends to act as a depressant on stock prices but not as an actual negative force. Or, more precisely, discount rate increases tend to mirror increases in market rates of interest which are the actual depressants on stock prices. Since it is always preferable to select the most direct indicator available, discount rate changes must defer to other interest rates as superior monetary forecasters of future stock market behavior.

The point to take here is that now is an especially keen time to monitor interest rates, as priced by the market. If short rates rise from here, we should accept this as a worthy depressant for stocks.

The Fed does not lead the market when it comes to rates (nor do heads talking), but the other way around. The market prices interest rates and ultimately the Fed follows suit. In this case short term rates had already moved-up (from essentially zero) before the Fed responded. Should we see further increase in short-term rates from here, the Fed will further increase the discount rate, as well as the more relevant Fed funds rate. Re-read this paragraph and you will be an expert on predicting the Fed.

Focus on how the various markets respond to market interest rates and vice-versa. Today’s action from the Fed may not yet be significant – how stocks trade in succession with interest rates will tell the tale.

And (in case you weren’t really sure or someone argues it doesn’t much matter), further increases down the line will become more and more of a depressant. Three Steps and a Stumble is a classic Fosback rule for changes in monetary policy and essentially insures some amount of hell lies ahead for stocks. This move is but number one – let’s now look to the rate picture as it develops to determine whether or not further steps are or are not yet looming.


About The Author
Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at various social media waterholes below.

  • Schwerepunkt

    Agree with your post; the thing about this discount rate move is it raises fear of a Fed Funds rate increase. Investors don't give a damn about the discount rate in and of itself. I remember when they lowered the discount rate in the middle of the financial crisis and the markets basically ignored it and kept dropping.

    But it is an inescapable conclusion that precisely because this was the universally acknowledged first move BEFORE a Fed Funds increase, now the market is worried about a Fed Funds boost followed up in a series. These things are almost never one-time events. Fed Funds Futures have already doubled to 50% the chance of TWO fed funds rate increases by the end of 2010.

  • Schwerepunkt

    Hmmmm . . . Chinese New Year Celebrations end this weekend. SSE is open for business on Monday. After their markets closed a week ago for the holiday, Beijing announced the raising of reserve requirements for Chinese banks. Now the US raised the Discount Rate. It might be a MASSACRE in Shanghai on Monday. The timing of all this should make any bull supremely worried. 10 Days to a new full moon on February 28.

  • https://evilspeculator.com molecool

    The Fed does not lead the market when it comes to rates (nor do heads talking), but the other way around. The market prices interest rates and ultimately the Fed follows suit.

    Exactly – to assume otherwise is to put the cart before the horse.

  • http://www.portfoliotilt.com PortfolioTilt

    Exactly, step 1, check.

  • BigHouse(Aka Mr Vix)

    Teddy Bear loves the Fed's news…..Going down……Fuck the news….Watch the idiots on CNBC spin the next dump

  • OldChicago
  • momac

    CZI is an ultra inverse China etf, might be a good time to buy a few shares tomorrow??? πŸ™‚

  • BigHouse(Aka Mr Vix)

    USD index is forming a triangle on a 1 hour chart… Expect higher prices come the morning…If not soooner…..I think the trade was buying puts on the Euro $ not the stock indexes a month ago..The drop on currency's has been very big..

  • BigHouse(Aka Mr Vix)
  • PRSGuitars

    FXP is more heavily traded, more liquid. Wouldnt touch CZI.
    Watch $DJSH for clues

  • BigHouse(Aka Mr Vix)

    Folks should be selling the rips in ES tonight….1095 good sell

  • fa_q

    Looks like I'm not going to get my last fill unless there is an OpEx miracle which I don't completely rule out. So I'm 3/4 full at 1094 and 1803. I'm aiming for 1040-1060 and will evaluate as we move down. So I'm currently down about 1 pt ES (75) and 2 pts NQ (75).

    '10 to date: +42 pts ES (100) and +61 pts NQ (100) on the trade I posted last month.
    Goal for '10 is 300 ES (100) and 500 NQ (100). So far, so good.

    Thanks for the Patek.

  • PRSGuitars

    Inclined to agree. Simply put, imagine how the nimble traders are the ones who got out either on the gap immediately following the Fed announce, or those who sell out quickly as we approach vwap (1097-1098 area tonight).

    There are MANY trapped traders come tomorrow morning. There's retail — the suckers — sure, but the regular e-mini big boys will rip things apart come 3:00 am EST or 7am, much less 930 am tomorrow.

    Oh, yeah, and all the regular-hours-only guys who represent massive funds trapped, looking to reduce exposure quickly. They'll show up at 9:30:01 with something fierce, I assume.

    Thus, sell the rips may be the path for tonight.

  • mmTesla

    Thanks for the patek indeed πŸ™‚

  • mmTesla

    I have an uneasy feeling about it, max pain is still 1100, they could easily walk it back up.

  • mmTesla

    Very true.

  • mmTesla

    Thanks for posting your charts πŸ™‚

  • BigHouse(Aka Mr Vix)

    Hee hee this is a night trade….till morning..Cover 1/2 trade at 1093 let the other position hit new lows per teddy bear dreams…

  • Bankster

    Can I ask you a question about Elliott Wave? I assume wave 1 down was from 1147 to 1040.75. Now wave 2 up to 1106.75 which is logical place to terminate since it is 50 day MA and also the 60% retracement of the wave 1 decline.

    Since EW says wave 3's are at a minimum 1.6 times wave 1, would you expect to see 170 points drop to 936? Just curious why you would aim for 1040 to 1060 when EW theory says it can go a lot lower.

    Thank you and I hope you hit your goal!

  • BigHouse(Aka Mr Vix)

    play 2 lots in ES tonight…Stick to the game plan..Don't go for the home run…Thats why i have long term puts….ES 109.375 now…It will sink back to the lows…DXHO is setting up for a new high tonight….Thats the key.

  • mmTesla

    Hope it goes well, I am looking to re-enter my short tmro, I closed nicely today AH. What is your target for next week? I'm thinking 1080-1075.

  • fa_q

    Sure I'm always up for talking EW when I have time. I don't like that count. I know a lot of people do. I'm not a big fan of that and I don't think 3 of (3) is coming right now. Hell, I don't think the ABC off the bottom in March has finished. I think we're in a flat to 1040-1060 for 4 of C and back to 1120 for 5 of C and then down. I know Fuji called it a Gartley or something. I don't know all of those formations. The reason I don't like the count that we finished C at 1150 and started down is the 1 down doesn't count properly. I know Mole has it as such, but I don't like it personally.

    However, I could be very wrong. That's why I stated my target and said I will evaluate as we go down. If it gets impulsive I will let it run. Or, I may throw a stop somewhere and see what happens although I hate to do that.

    EW is far from perfect. I use it to establish the probable course, or rather, the course with the highest percentage of likelihood. Based on that I run my trades.

  • BigHouse(Aka Mr Vix)

    940 in the next 2 1/2 weeks on ES if this is the next major leg down per Teddy Bear….

  • jacksoo

    what is your 'miracle' last fill tgt faq?

  • fa_q

    I've got a sell for the last quarter at 1112

  • jacksoo

    Some EW counts post to a bounce from 1092-1090 area upto as much as 1115 –
    does this fit with your thinking re 1112 order?

  • fa_q

    Your 1st statement was good. 1.62 is a nice general rule of thumb for a 3. I knew what you meant. My alt count, the count that has us about to hit 3 of 3 is 950. I just don't like that. If you dig up that post by Fuji you'll see the Gartley, it's the same as my count of the flat.

  • fa_q

    Yup. My gameplan was 1/2 at 1092, 1/4 at 1098 and 1/4 at 1112.

    In reality I will add if we start to drop but if I can't post it here I won't credit it. That's why I set up my levels beforehand because my ability to post here is spotty at best these days.

    By the way, I would not be shocked to see us creep up to pin the open at 1100. After that, anything can happen.

  • jacksoo

    Went short today at 1098.50 out at 1094 – long at 1093.75 looking for
    1100ish or better – -break down below 1090 for s/l and reversal short –
    -what's your tgt for break down and going/adding short faq?

  • mmTesla

    That is quite along ways, I think it all comes down to Greece.

  • https://evilspeculator.com molecool

    “Since EW says wave 3's are at a minimum 1.6 times wave 1”

    WHERE did you learn all that crap?

  • momac
  • http://retracementlevels.zstock7.com/ zstock, Pro Select!

    If Fri, turns into an all day carnage, ( RTH is going down.) there's intraday support on the DIA at 102.5 – 102.7

  • http://retracementlevels.zstock7.com/ zstock, Pro Select!

    SPWRA, you'd at least think it could get back to its 50 day , 22.7. ** 19's is another buying opportunity, HSI down like 500 in overnight. So you just might get 19's.

  • PRSGuitars

    Link to Fuji's post, Gartley mention is halfway in…

    http://slopeofhope.com/2010/02/feb-option-expir

    Welcome back, Faq. Great to hear from you again. Your timing is evilly awesome, like the grim reaper of shorting. Bravo.

  • PRSGuitars

    Bear porn.

  • fa_q

    Grim reaper of shorting. I love it!

  • http://oahutrading.blogspot.com/ steveo77

    My Real Trade Ideas
    Don't do what I do, I am plumb loco!

    I have mostly near term short positions, and one long (NQ futures).

    I expect a bunch of bears to jump into the fray tomorrow AM…..then with tinfoil hat firmly in place….a massive ramp at end of day, trapping most bears. Then lots of upbeat media over the weekend stating how the economy is so good we can raise rates….

    But as corrupt as these guy are, don't think they are pure dumb. That currency swap thing for like $650B they did, actually turned out in the US favor, and it did greece the worlds wheels a little.

    This maneuver can make flight to dollar strong, perhaps flight to Gold strong as Europe wants to sell gold.
    From my previous post, the idea is from Jammermpu, but charts are from me….this could be a very bullish run….a final crushing of the bear spirits….many bears will just try to get a job they will be that desperate!

    http://oahutrading.blogspot.com/2010/02/my-real

  • bobthehorse

    In answer to your comment on the previous post, I did not expect an iintra-meeting move on the discount rate although Bernanke did flag it in a speech last week. That they have now moved so quickly suggests CPI today will be well ahead of consensus.

    I have a predictive model of CPI that I use and it points to a headline number in excess of 4%, consensus is looking for 2.8%. The Core number won't be anywhere near that though but might come in above 2%.

    This move in the discount rate is probably a pre-emptive signal that they have it in control. They don;t of course but there you go.

    I'd not get too excited about the downside. Bond markets are not yet signalling a proper rate hike is imminent – still some way off. I would not rule out 1121 at all. Still very unclear as to the short term path, I would buy at 1092/90 on ESH0 for a trade, running a tight stop. Would not be short today – better to come in on Monday and find a decent level.

  • PRSGuitars

    You appear; shit dies.

    Works for me, I'm in Mar 113s entered near 1105 /es today. 50% position but
    who cares… happy to see your targets are well on their way to being met.

  • gatopeich

    Good morning, great post!
    Red Europe, but no panic.
    As usual, we'll be waiting for US to go hand in hand into… whatever!
    Fed news effect made for a one percent move in a pretty overbought market.
    The good thing is that we will finally stop wondering “P3 or not P3”.
    I am currently aiming at IBEX's last lows, just -7% from here.

  • tradejane

    Well said Michael, personally I wouldn't short here if not short already.

    My plan was to close positions if the DAX closes/gaps above 5700 and I fully expected that to happen as the index was trading above that level after hours. It didn't happen but we didn't have a breach of 5620 either. So we're still in limbo.

  • http://chartsandthat.blogspot.com/ ultra

    Great post, Michael. Good to see you back on the field.

    Point is well-taken about the Fed following the market. So, with that in mind – is that the MACD about to roll over on 3-month Treasuries (bit of a divergence there too)?

    http://stockcharts.com/h-sc/ui?s=$UST3M&p=D&b=5

  • spicestory

    Michael, that is an eye opening post, thanks a ton. HangSeng and Nikkei nosedived since opened and didn't get above water ever after, both close at over -2%, while DAX and FTSE are just have a small blip. Presumably, Asia and EU are on a different sub-wave countings or are on a different interpretation on the rate change at least in short term

  • http://chartsandthat.blogspot.com/ ultra

    Only thing I'm thinking here is that it often pays to fade the first reaction after this kind of announcement. Thoughts?

  • http://sshamster.blogspot.com/ Stainless_Steel_Hamster

    “the Fed follows suit”

    i think that is what EWI has been saying for ages

  • CorporalCarrot

    I would have thought this a relative non-event folks, although with the number of vaccines I've received in the last few weeks I might not be thinking straight.

    I can see the selling petering out after a half hour or so and then a pop & grind into the close, with us ending up only slightly down or up on the day. Can't see this developing into anything more at this point.

  • tradejane

    “For every action there is a reaction.”

    I knew those 9th grade physics would come handy one day!

  • goldpackers

    Oil, stocks and gold not following $ that closely today. If it closes above 81 DXC, should get pretty decent selling in all into the end of next week.

    Gartley ~ 1060 spx ? ~ 1109 achieved

  • gmak

    I really hate to put up my post on top of this. It's important. I'll put a link in my Broken Clock back to here for latecomers.

    https://evilspeculator.com/?p=14651&success

    NEW POST
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  • momac

    thanks for the tip. πŸ™‚

  • http://chartsandthat.blogspot.com/ ultra

    Great post, Michael. Good to see you back on the field.

    Point is well-taken about the Fed following the market. So, with that in mind – is that the MACD about to roll over on 3-month Treasuries (bit of a divergence there too)?

    http://stockcharts.com/h-sc/ui?s=$UST3M&p=D&b=5

  • spicestory

    Michael, that is an eye opening post, thanks a ton. HangSeng and Nikkei nosedived since opened and didn't get above water ever after, both close at over -2%, while DAX and FTSE are just have a small blip. Presumably, Asia and EU are on a different sub-wave countings or are on a different interpretation on the rate change at least in short term

  • http://chartsandthat.blogspot.com/ ultra

    Only thing I'm thinking here is that it often pays to fade the first reaction after this kind of announcement. Thoughts?

  • http://sshamster.blogspot.com/ Stainless_Steel_Hamster

    “the Fed follows suit”

    i think that is what EWI has been saying for ages

  • CorporalCarrot

    I would have thought this a relative non-event folks, although with the number of vaccines I've received in the last few weeks I might not be thinking straight.

    I can see the selling petering out after a half hour or so and then a pop & grind into the close, with us ending up only slightly down or up on the day. Can't see this developing into anything more at this point.

  • http://twitter.com/tradejane tradejane

    “For every action there is a reaction.”

    I knew those 9th grade physics would come handy one day!

  • goldpackers

    Oil, stocks and gold not following $ that closely today. If it closes above 81 DXC, should get pretty decent selling in all into the end of next week.

    Gartley ~ 1060 spx ? ~ 1109 achieved

  • gmak

    I really hate to put up my post on top of this. It's important. I'll put a link in my Broken Clock back to here for latecomers.

    https://evilspeculator.com/?p=14651&success

    NEW POST
    NEW POST
    NEW POST
    NEW POST
    NEW POST
    NEW POST
    NEW POST

  • momac

    thanks for the tip. πŸ™‚