The S&P 500 has had a small wobble following the Fed’s announcement that it is raising the discount rate. As usual, the size of the decline is not as big as the media’s reporting would suggest — which is a shame, because I thought it could be a buying opportunity.

Lending from the discount window is an emergency liquidity measure. The Fed allows banks to borrow money in order to meet their short-term obligations if they can’t get the money elsewhere for some reason. As I recall, the spread between the discount rate and the Fed funds target rate (the main policy rate) was 1% before the crisis. It was cut to 0.25% as the crisis went on and lack of liquidity became a major problem. Now that banks are lending to each other again (they are no longer terrified that their peers will go bust), there is no need for a super-cheap liquidity facility. So the raising of the discount rate is a sign that the Fed is confident in the recovery of financial markets, not that it has imminent plans to raise the Fed funds target rate.

So should I buy the equity market? My metrics — momentum, liquidity, sentiment, valuation and economic growth — say yes. Technical analysis doesn’t have much to say. A strong break above 1100 could be a buy signal.

(Actually, these are not my metrics by Jack Ablin’s — with some modifications of my own — but I find them very useful).

Update: Great intro from Bloomberg: “The Federal Reserve Board sent its most explicit signal yet that the emergency supply of liquidity to financial markets is done and the most aggressive monetary policy easing in its 96-year history will eventually reverse.” Note the concatenation of liquidity and monetary policy (admittedly the Fed seems to have blown hot and cold over this distinction in the past). The Fed’s move is a signal of a reduction in the emergency supply of liquidity, in the sense that it is a reduction in the emergency supply of liquidity. Signalling that “aggressive monetary policy easing” will eventually reverse seems unlikely to be an objective of the move. Some might think the Fed is signalling that its main policy rate will rise sooner rather than later; I think that it is signalling no such thing. But “eventually reverse”? Do they think the Fed is trying to remind us that all things must pass?