I’ll give the Federal Reserve this, their TAF program has succeeded in bringing down US Dollar LIBOR rates relative to Treasuries and Fed funds.? I did not doubt that they could succeed at doing this; my main concern is what happens when they stop doing this.? Flooding the short end of the yield curve with liquidity has overwhelmed those seeking permanent liquidity cheaply, by offering large amounts of temporary liquidity cheaply, and saying that the program could become a regular part of the Fed’s policy tools.

So, the most recent auction priced out at 3.95%, well below the Fed Funds target of 4.25%, and below where Fed Funds have averaged recently, which is around 4.15%.? Why borrow at Fed funds if the TAF is available?? The TAF can accept a wider array of credit instruments as well.? Why even give a second thought to the discount window at 4.75%, if the same collateral can be financed by the TAF?? Granted, the rate was above the expected fed funds rate for the next month, but using that as a guideline is tantamount to surrendering control of the money supply to the Fed Funds futures market.

Looks like a win for the Fed, at least in the short run.? The long run could be a different story.? The old rule of Walter Bagehot was for the central bank to unlimitedly lend against secure assets at a penalty rate in a crisis.? In this case, it is lending against less than top-quality assets at what is a bargain rate.? In the long run, that is a recipe for monetary and price inflation.? Though longer-dated TIPS don’t reflect that future consumer price inflation, I expect that they eventually will.