The Stock Market and the Discount Rate Increase: Damage Control and Mixed Messages!

Although the FOMC minutes released Wednesday indicated that raising the discount rate penalty over the federal funds rate was the next step in removing quantitative easing, virtually no one expected that this step would be taken so quickly. The Fed has typically telegraphed moves like this quite clearly in the recent past. When the actual event has occurred, it has usually been fully expected.

The timing of the announcement is highly unusual since it comes on an options-expiration Friday when volatility and uncertainty is high. A tame CPI report also indicated no urgency to counter inflationary pressure.

People are now wondering if this is the start of monetary tightening even though the Fed decision last night indicated "that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." If it is not, the market is left wondering what the true message behind the rate move is. As a result, the Fed is now in a damage control mode, which is highly unusual.

The markets will probably be on edge until the Fed Chairman's speech next week in which he will be able to clarify the meaning and implications behind the rise in the discount rate. It is quite surprising that Dr. Bernanke did not use the speech to telegraph his intentions and then raise the discount rate afterward. Markets will remain on edge until then.

Doug Roberts is the founder and chief investment strategist for ChannelCapitalResearch.com, an independent research firm focusing on investment strategies using the Federal Reserve's impact on the stock prices. He is a corporate speaker and consultant, the author of Follow the Fed to Investment Success and an expert on FreePassers. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.