Wall Street loans mean no rate hikes

By Katie Benner

The Federal Reserve will hold off on an interest rate hike until central bankers first stop providing loans to Wall Street banks, according to a Bloomberg report. For as long as the Fed has to maintain (or even extend) its emergency lending program, the report says, it’s unlikely that the market will be stable enough to handle higher borrowing costs.

“We think they’ll wait until 2009,” Brian Sack, who used to head the Fed’s monetary and financial market analysis group before he joined Macroeconomic Advisers, tells Bloomberg. Successfully dealing with an end to the Primary Dealer Credit Facility is “a hurdle for credit markets to get past before the Fed will likely start tightening,” he said.

The Fed opened its window to investment banks in March after the near-bankruptcy of Bear Stearns, which sold for cheap to JPMorgan Chase (JPM), in an effort to keep markets calm. The decision to make Fed loans available to a group of institutions that include Lehman Bros. (LEH), Merrill Lynch (MER), Morgan Stanley (MS), and Goldman Sachs (GS), was highly unusual. The Fed had traditionally provided loans to commercial banks but not investment banks. New York Fed President Timothy Geithner said in early June that as long as markets were distressed, the emergency measure would remain in place. However, part of the Fed’s plan to keep the economy on track has meant maintaining low interest rates. With energy and food prices rising fast, inflation has become a serious concern and some economists think it’s time to raise interest rates.

The market has priced in 74% odds or a rate hike by the end of 2008, but those odds might be overly optimistic given that people are still hesitant to lend and Wall Street is still perceived as weak, Bloomberg says. The next rate hike, whenever it comes, will be the first increase since 2006.