Rise in Federal Funds Rate, Tighter Reserves Indicate Action by Fed

The Federal Reserve appears to have tightened credit a bit, moving to snuff out inflation before it becomes a problem, analysts said Monday.

They pointed to two telltale signs: An unexpectedly tight allocation of reserves by the Fed on Monday and a rise in the federal funds rate--the amount banks charge each other for short-term funds used as reserves.

Other key interest rates rose to the highest level of the year during the day on the credit market, reacting to the suspected Fed tightening and recent signs that the pace of the economy is quickening.

“It looks like the Fed has snugged here,” said James Blumenthal of Irving Securities Inc. “Unless there’s a real surprise . . . and forecasts are way off.”

But analysts say the Fed will tread lightly in credit markets, remembering that its last move to tighten--its hike of the discount rate last September--was partly blamed for the October stock market collapse.

Also, Federal Reserve Chairman Alan Greenspan will be reluctant to make any overt waves in an election year.

Stingier Than Expected

A more restrictive policy that triggered a recession would hurt his Republican colleagues’ chances of keeping the White House. Too lenient a policy, aside from encouraging inflation, leaves the Fed open to charges of electioneering.

Thus, analysts have been forecasting subtle moves--nothing as dramatic as a discount rate hike but moves which, nonetheless, will boost interest rates throughout the economy.

Bond dealers detected Fed action on Monday, noting that the U.S. central bank was stingier than expected in adding reserves to the banking system.

The result was that the federal funds rate, the amount that banks charge each other for overnight cash reserves, edged up to over 7% from just over 6.75% last week. Federal funds are viewed as the most sensitive indicator of the central bank’s monetary policy.

The closing yield on the benchmark 30-year bond rose to 9.18%, matching the year’s highest yield on Jan. 8.

Some predicted that banks may soon raise prime rates to reflect the higher cost of borrowing.

“We’re very surprised the (federal) funds rate has hung in under 7%,” said Andrew Baur, the chairman of Southwest Bank of St. Louis. The small but influential bank is often a trend setter for major banks in New York and Chicago.

Gradual Move Desired

“As soon as we see it jump over (a sustained average of) 7%, we’ll see the prime rate move,” he said in an interview.

While economists say the 8.5% prime rate being charged by banks might rise to 8.75%, the key discount rate is not likely to be moved from its current 6%.

“A discount rate move is too dramatic, too visible,” said Blumenthal of Irving.

“You have to remember last October when the Fed was blamed for the (stock market) crash for raising the discount rate,” he added. “Whether it was right or wrong to blame them, they’re going to want to make a gradual move.”

The Fed has been allowing such a shift since Friday, allowing federal funds to rise. If the Fed had wanted to bring them back down, they would have done so Monday morning.

“They could have done a rate protest with a large customer or systems operation today,” said James Fralick, senior economist at Morgan Stanely & Co., referring to two methods of injecting liquidity into the banking system. “But given the unemployment rate Friday, they had to do something here.”

Economists said Friday’s April U.S. employment rate was probably the factor that forced the Fed’s hand. The jobless rate dropped to a 14-year low of 5.4%.