December 13, 2007 / 12:00 AM / 13 years ago

Fed liquidity move mostly gets thumbs-up

NEW YORK (Reuters) - One day after the Federal Reserve disappointed many investors at its final meeting of the year, the U.S. central bank helped salvage its reputation on Wednesday with an innovative plan to ease stress in global credit markets.

Senior Portfolio Manager for Horizon's Investment Management Operation Jill King speaks at the Reuters Investment Outlook Summit in New York December 12, 2007. REUTERS/Brendan McDermid

Analysts, including participants at the Reuters Investment Outlook 2008 Summit in New York, gave a guarded thumbs-up for the plan, which came the day after the Federal Open Market Committee took action that many thought was not sufficiently aggressive amid a climate of financial turmoil.

When Tuesday came and went without word of measures to address credit market stress, some Fed watchers questioned whether policy-makers understood the severity of the market’s liquidity squeeze. But Wednesday brought redemption in the form of a plan, in concert with other central banks around the globe, to make it easier for stressed banks to borrow money.

“The Fed ... will provide liquidity that is desperately needed,” said Jill King, a senior portfolio manager at Horizon Cash Management in Chicago. “It keeps us from a very scary situation.”

Short-term interbank lending rates, including the London Interbank Offered Rate, have been elevated since credit market turmoil erupted in August. Problems had been expected to come to a head around the turn of the year.

“Is this a panacea, a cure? Probably not. But it’s a sign that the Fed is thinking creatively,” King said.

Analysts said the Fed — by not announcing the liquidity plan at the end of its policy-setting meeting on Tuesday — seemed to be differentiating between its two roles.

“Yesterday was for the economy. Today was for the market, and for liquidity,” King said.

Still, some questioned the wisdom of delaying word of the liquidity steps and wondered if the timing was driven by the savaging taken in U.S. equities markets on Tuesday.

“If the Fed would have announced the new facility yesterday and the G7 coordination, couldn’t a great deal of market turmoil have been avoided?” Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said in a research note.

Rich Berg, chief executive officer of Performance Trust Capital Partners in Chicago, said the Fed’s moves were a way to target “a big, trillion-dollar toothache” in money markets.

“They needed to give something very specific to the tooth, not just another dose of Tylenol,” Berg said.

Still, if one part of the Fed’s two-pronged approach was praised, that left a second to be criticized.

Tom Metzold, who manages over $8 billion in municipal bonds at Boston-based Eaton Vance, said the Fed is exposed on the monetary policy front by a cumulative 100 basis points in cuts to its benchmark lending rate since mid-September.

That full point of easing within three months is one of the Fed’s most rapid periods of monetary ease, equaled or exceeded only when the economy has been in recession.

“The Fed has to be very careful about overreacting ... They’re on the razor’s edge,” Metzold said. “Inflation is a concern. And an inflationary spiral is much more damaging to the economy than an economic slowdown and a recession,”

Fed Chairman Ben Bernanke “has stated publicly he will not return to the inflation spirals of the 1970s and early 1980s,” said Metzold, who declared himself a Bernanke fan. “I would like to see him be more slow and steady.”

The Fed’s plan includes the establishment of new weekly and bi-weekly term auctions, allowing banks to obtain funds through an anonymous bidding process.

Senior Portfolio Manager for Horizon's Investment Management Operation Jill King speaks at the Reuters Investment Outlook Summit in New York December 12, 2007. REUTERS/Brendan McDermid

The bank has committed to two auctions of $20 billion each in December, just in time for what some fear will be the mother of all year-end liquidity crunches.

“We won’t really know the impact until the first auction goes off, see the bid to cover, and so on. But it can help financial institutions and I think it’s a positive step,” King said.

(For summit blog:

Reporting by Ros Krasny; Editing by Leslie Adler

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