Commentators seem to be split on the important of the Fed’s 1/4 point hike in the discount rate yesterday after the close. Some say it’s meaningless and not to worry about it. Others see it was one of the first steps in a tightening program that will remove the liquidity that has stabilized the economy and propelled financial markets over the last year. I believe the latter have it right.
The stabilization in the economy and strength in financial markets, in my opinion, is almost entirely about support provided by the government, especially the loose monetary policies of the Federal Reserve. While this is a small move, it has symbolic significance. In conjunction with the Fed’s letting many of its special programs expire earlier this year, which they first announced in their Dec. 16, 2009, statement this is just another move towards tightening. If it was loose monetary policy that goosed markets, monetary policy will go from being a tailwind to being a headwind. The easy money has been made, the junk phase of the rally is over.