February 22, 2010The Consumer Price Index (CPI) rose 0.2% in January following similar gains in each of the prior four months. During the September-January period, the energy price index has posted significant gains ranging from 0.6% to 2.8%. The largest increase of the energy price index (+2.8%) has occurred in January. The energy commodities price index moved up 4.9%, inclusive of a 4.4% jump in gasoline prices, 3.5% increase in natural gas prices, and a 6.1% gain in heating oil prices. The energy price index has risen 19% from a year ago. Food prices climbed 0.2% in January, translating into a 0.4% drop during the past year but the index has risen 1.9% in the three months ended January.
Conclusion - Inflationary pressures are not visible in the January CPI report. The main focus of Fed policy continues to be economic growth and jobs. However, the Fed is responding to improvements in financial markets by eliminating emergency measures put in place as the crisis unfolded in August 2007. The first measure, in addition to programs dying a natural death, was the discount rate increase announced after markets closed on February 18. The FOMC raised the discount rate to 0.75% from 0.50%, effective February 19. The term of discount window loans will be shortened to overnight as of March 18, 2010 vs. the current 28-day term. Chairman Bernanke's testimony on February 10 and the minutes of the January 26-27 FOMC meeting published on February 17 contained broad hints that the discount rate hike would be the first move toward removing the financial accommodation put in place after the financial crisis began in August 2007. The spread between the discount rate and the federal funds rate has increased to 50 bps points from 25 basis points. The Fed's move is essentially an action to recalibrate financial market rates to the situation prevalent before the onset of the crisis. As the fed mentioned in the official announcement, this action is not to be seen as a tightening of monetary policy. The main implication of this action is that the interbank loan market has mended and is on the way to a pre-crisis status. Loans extended under the discount window during the crisis approached a peak of roughly $110 billion; as of February 17, 2010, borrowing through the discount window dwindled to $14 billion. (see chart 2).
To put matters in perspective, the Fed lowered the discount rate (primary credit rate) to 5.75% as of August 17, 2007 bringing the spread between the federal funds rate and the discount rate to 50 basis points from 100 basis points. The Fed also lengthened the maximum maturity to 30 days form overnight. This was, in fact, the first policy action taken in response to the financial market crisis. On March 16, 2008, the Fed lowered the spread of the primary credit rate to the federal funds rate to 25 basis points and extended the maturity of these loans to 90 days. As financial market conditions improved, on January 24, 2010, the Fed reduced the maximum maturity of discount window loans to 28 days from 90 days. Economic data continue to drive home the point that although an economic recovery is underway, the pace of the economic activity is sub-par, at best, and the unemployment rate remains at a worrisome level. Therefore, the discount rate action should be viewed as a removal of an emergency measure in response to an improvement of inter-banking conditions. New York Fed President Dudley and St. Louis Fed President Bullard, both voting members of the FOMC, indicated in their speeches, after the announcement of the discount rate change, that the discount rate hike is a technicality and not a signal of a tightening of monetary policy.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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