Fed Recap 10-07-2008

[fx_analyst]

Recently, the Fed has undergone many changes that may have gone unnoticed by most people. One of the most important changes has been the Fed's ability to now pay interest on reserves. They will be paying 75 basis points below their target rate. So , with the current 2% Fed Funds rate, they will be paying 1.25% interest on the reserves that banks keep with them. What this has done is effectively put a floor on what banks can borrow for since a bank will not lend for less than what they earn for just leaving their money with the Fed. So,the Fed can pump a lot of money into the system, weakening the dollar,without lowering their target. This is important because they do not need to lower their rate to increase liquidity.

Second, they have doubled the amount they will offer in their term auction facility to a total of $900 billion. These are short term loans from the Fed to banks which are being used in an attempt to increase liquidity. Additionally, the Fed has announced that they will be purchasing commercial paper, these are essentially credit cards for large firms. They have yet to announce an amount, merely stating that they will be participating in the market.

The important thing that a trader needs to realize at this point in time is that the Fed has greatly expanded its ability to control the supply of dollars without affecting its target interest rate. Of course other interest rates will be affected and there is nothing that the Fed can do to change that. But, you are going to have to look beyond the Fed Funds rate to figure out what the fed will be doing to the supply of dollars in the economy.

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David Leal
Market Analyst
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Yahoo IM: IFXleal
DLeal@IntegrityFXllc.com
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