Discount rate cut - good news

The Fed cut the discount rate to banks from 6.25% to 5.75 or 50 bps. This action was done because there was the perception that the downside risks to the economy have increased appreciably. This has caused a significant turn around in the markets. Additionally, their statement states that they will provide term financing for all type of collateral. This is a rare intra-meeting move by the Fed which further increases the announcement effect. This move will allow the markets to gain some time to review portfolios and let liquidity back into the market. Allowing the banks to borrow at the discount rate should help with the liquidity issues of commercial paper and back-up credit line from banks.

This was a deft move by the Fed because the Fed funds target rate was left unchanged. The discount rate has usually not been used as an active policy tool separate from the Fed funds rate. Of course, there is talk of this move continuing the perception of the "Greenspan put". nevertheless, the contagion effects across markets and the closing of liquidity in the money markets reached a level that some action was necessary.