Fed Befuddles Market

The Fed, the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank announced plans Wednesday morning to create a term auction facility to add more than $40 billion of liquidity in four separate operations. As the Fed puts it, the move is "designed to address elevated pressures in short-term funding markets."

To say that traders were flummoxed would be an understatement. Market participants have spent the day wondering why the Federal Reserve wouldn't have made this announcement Tuesday ahead of their decision to cut the fed funds rate by 25 basis points to avoid roiling the markets. The Fed's official line was that the central bank wanted to be fair and make the statement when European markets were open.

"It is very strange, and raises more questions than it answers," says Michael Darda, chief economist at MKM Partners.

A New Influence on Libor?

The big question is, can the term auction facility do what the fed funds rate used to do, which is influence the Libor rate, or market-driven London interbank offered rate? Making Libor lower means making the economy's most meaningful interest rates lower. A lower Libor rate can unlock the current credit market seizure, bring down borrowing costs for financial institutions and possibly stem the tide of foreclosures and economic contraction.