Federal Reserve Forces An Attitude Adjustment with Surprise Discount Rate Hike

(A version of this post also appears on Inflation Watch)

The Federal Reserve essentially warned us in its most recent written testimony to the House of Representatives that part of its exit strategy from emergency monetary measures is to increase the spread between the funds rate and the discount rate. This evening, the Fed did just that. In a surprise announcement, the Fed increased the discount rate from 1/2 percent to 3/4 percent and accordingly widened the spread with the funds rate.

Once again, the Federal Reserve reassured us this action does not change monetary policy:

“The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC).”

This caveat probably means we should still not expect an increase in the funds rate until November/December at the earliest. However, I think the Fed’s surprise delivery of this message puts us all on notice and forces an attitude adjustment. The Fed is serious about policy normalization, and maybe, just maybe, it will do its part to protect the dollar’s future.

The Fed’s timing is particularly odd given options expire tomorrow. Typically, such timing is executed to squeeze shorts and force a market rally. I cannot see the market rallying on this news (in the short-term), and there could be a lot of chaos as market participants rush to adjust in the middle of dealing with expiring options. In fact, given over-bought technical conditions throughout the stock market, the selling I thought would be postponed until Monday may start tomorrow in earnest.

Overall, I am personally still absorbing this news, but I highly suspect my appetite for commodities will subside significantly for now. The dollar’s short-term technical strength should now get even stronger and last even longer.

Be careful out there!

Full disclosure: long SSO puts, QQQQ puts