Central banks extend emergency credit; rate hikes less likely

And now you know why gold has been bombed this week.

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Central Banks Fire New Round at Credit Crisis

By Glenn Somerville
Reuters
Wednesday, July 30, 2008

http://www.reuters.com/article/ousiv/idUSWAT00986620080730

WASHINGTON -- The U.S., European, and Swiss central banks on Wednesday extended emergency lending facilities for investment banks and expanded other liquidity programs to ease credit market strains that have weighed on the global economy for nearly a year.

The joint measures helped lift share prices in the United States and Europe and were a factor in pushing up U.S. bond yields and the U.S. dollar.

The U.S. Federal Reserve said it was prolonging until Jan. 30 the emergency credit facility for primary dealers that had been due to expire in mid-September.

The Fed said it acted "in light of continued fragile circumstances in financial markets," and said it would close the lending program once it determined credit market conditions were no longer "unusual and exigent."

The Primary Dealer Credit Facility was launched in March after the near bankruptcy of Bear Stearns and it marked the first time since the Great Depression that the Fed had opened its emergency lending to investment banks.

Some analysts said the latest action suggested the Fed would be loathe to raise interest rates any time soon and interest-rate futures showed traders trimming back bets on the Fed raising rates this year.

"Until the Fed starts scaling back or eliminating its special liquidity-providing measures, rate hikes would create a glaring policy inconsistency -- conducting measures that effectively lower borrowing rates while simultaneously raising them," Michael Gregory, a senior economist at BMO Capital Markets in Toronto, wrote in a note to clients.

The Fed also said it would offer longer-term loans to banks under its Term Auction Facility, introducing 84-day offerings in addition to its current 28-day loans. The TAF was established in December to try to tamp down funding pressures.

The Fed plans alternate auctions of $75 billion in 28-day credit, with offerings of $25 billion in 84-day funds every two weeks. Credit outstanding at the Term Auction Facility would total no more than $150 billion, as is currently the case.

In parallel, the European Central Bank and Swiss National Bank said they would begin conducting U.S. dollar auctions with 84-day terms, in addition to their current 28-day offerings, alternating on a bi-weekly basis. Auction maximums would be $2 billion for the SNB and $10 billion for the ECB.

The Fed said it would temporarily expand its dollar swap line with the ECB to $55 billion from $50 billion. The Fed had put in place swap lines with both the ECB and SNB so that those central banks could provide dollars to European markets.

... Extra liquidity helpful

The announcements followed record demand for U.S. dollar liquidity at the ECB's last 28-day auction, when banks bid for more than four times the $25 billion on offer.

Economists and traders said the move, which pushed down euro zone government bond and Euribor interest rate futures, showed the seriousness of money market tensions a year after the initial credit-market shock.

"The extra liquidity is helpful but there is more need for funding over longer-term horizons," Commerzbank economist Michael Schubert said.

The Fed's actions are the latest in a series of aggressive steps, in conjunction with the ECB and the U.S. Treasury, to calm financial market strains resulting partly from huge writedowns by banks on mortgage related assets as U.S. house prices have tumbled in the past year.

President George W. Bush on Wednesday signed into law a sweeping housing market rescue package that would provide mortgage refinancing for stressed borrowers and provide emergency funding for mortgage market giants Fannie Mae and Freddie Mac.

A day earlier, the U.S. Securities and Exchange Commission extended its crack-down on abusive short-selling in the stocks of 19 major financial firms.

The Fed said that in addition to extending the PDCF, it would also keep open through January 30 its Term Securities Lending Facility, which provides liquid Treasury securities for 28 days in return for harder-to-trade collateral.

It also gave the go-ahead to the New York Federal Reserve Bank to auction options to primary dealers to borrow Treasury securities to ease funding pressures that often build as financial quarters are drawing to a close.

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