Fed discount rate hike?

Might the Fed raise the discount rate at this week’s policy meeting? I think this is a possibility and should be considered as a risk factor. But I would not include a discount rate increase in my base case forecast for the meeting.

The Fed will I think seek to draw an increasingly sharp distinction between liquidity policy and monetary (interest rate) policy in the spirit of the ECB’s separation principle at this meeting and in subsequent communications.

Policymakers are already some way towards the exit in liquidity policy and may want to accelerate this dimension of policy normalisation. By contrast they see rate normalisation as still some way off, even though they are aggressively testing the tools for doing it now.

A good case can be made that advancing normalisation on the liquidity front would logically involve raising the discount rate and doing so sooner rather than later.

But I think the odds are against it happening at this meeting because a) we’re approaching the year end b) it might be misinterpreted as a signal that rate increases are coming soon c) the Fed has not decided what type of rate system it wants to end up at post-crisis (hard floor vs corridor?) and this may have implications for the “new normal” discount rate spread over the fed funds rate.

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