Credit spreads have started to narrow now that the Federal Reserve has reestablished its attempt at global leadership.  Notice the word attempt.  

We seem to see that the Fed finally “gets it.”   It appears they realize how endangered the economy of the US and the rest of the world is when credit markets are dysfunctional.  Only time will tell IF they actually have a grasp.  At Cumberland we believe the answer to this question will be yes and that the Fed will not permit dysfunctional credit markets to trigger a serious and potentially global recession.

The mechanics are evolving.  The Fed HAD three basic operating tools.  They are the Open Market Operations, the Federal Funds Interest Rate and the Discount Window Interest Rate and usage conditions.  The Term Auction Facility (TAF) is now the fourth tool in use.   It is a big weapon.

Yesterday, Fed member banks that were deemed to be in “sound financial condition” were joined by foreign branches or agency affiliates in the process of accessing the TAF.   Those that wished to bid for money submitted their telephonic bids to one of the twelve regional Federal Reserve banks.   If successful as a bidder, there is a collateral requirement which is clearly developed and which is parallel to the collateral use for Discount Window borrowing. 

Tomorrow the results of this auction will be announced.  On Thursday, $20 billion will be funded into a 28 day loan to the winning bidders. There is a limit of $2 billion for any one bidder.  There is a minimum bid yield of 4.17% which is determined by a reference interest rate.  That rate is the average “expected overnight Fed Funds rate of the term being auctioned.”

Ok, the minimum yield is 4.17%.  The Federal Funds target rate is 4.25%.  The Discount Window rate is 4.75% for banks in sound financial condition.  1-month LIBOR is about 4.95%.   This means a bank or foreign qualifying entity is induced to bid somewhere between the 4.17% low and one of the other reference rates. 

The market is keenly looking for the details that can help assess the outcome of TAF.  What is the bid-to-cover ratio?  What is the range of bids?   Is there any indication that the $2 billion limit discouraged large users?  Will this new facility help or hinder the Fed’s attempt to de-stigmatize the Discount Window?  Will Discount Window use go up or down?  Would the Fed achieve better results with unlimited bids at a specified interest rate as is done in other jurisdictions? 

We may learn a lot more about this tomorrow.