Market Overview

Marketfy Maven

Sign up to get updates and product information from this Maven

Dave & Donald Moenning

Mr. David Moenning is a full-time professional money manager and is the President and Chief Investment Officer for his Chicago-based Registered Investment Advisory firm, Heritage Capital Management (...

>> Read more from this author

Product Performance

Lessons From The Fed: 'Zero Interest Rate Policy' Trumps Taper

For weeks, the question of whether or not the Fed would begin tapering their QE program was the focus of the stock market.

After each and every economic report, the issue was always the same: Was good news bad for stocks because it meant the Fed would start pulling the punch bowl? Or was good news actually good because it meant that the economy was improving?

In reality, both arguments have merit. So, as far as the stock market has been concerned, Goldilocks became the desired outcome for most economic reports. The hope was that the data wasn't so strong that it would encourage the Fed to take action or weak enough to create worry about the economy slipping into recession.

So, going into the all-important FOMC meeting yesterday, the general consensus was that if the Fed decided it was time to taper back their bond buying program, stocks would fall. And if the committee deemed the economy weak enough to continue to need the FOMC's full support, stocks would rise.

Wait, Does That Even Make Sense?

To be sure, this line of thinking is more than a little convoluted. Shouldn't everyone in the good 'ol USofA be rooting for the economy to improve?

At issue here is the idea of global liquidity. With the central banks of the world flooding the financial system with cash (the U.S. and Japanese central bankers alone are pumping out nearly $2 trillion a year), the bottom line is that newly minted money has to go somewhere. And over the past year, an awful lot of that cash has found its way into the U.S. stock market. Thus, the worry is that if the Fed stops the printing press, demand for stocks could decline.

See also: Two Sell Signals to Watch for in 2014

Then there is the "carry trade." If you are a big - really big - institution, the Fed's ZIRP (Zero Interest Rate Policy) means that you can borrow at zero percent and invest that money. So, yes Virginia, there is indeed a free lunch available if you're the size of Goldman, JPMorgan, Citadel, etc.

Wasn't The Taper Supposed to be Bad?

So... when the FOMC announced that it would begin reducing their monthly bond purchases from $85 billion a month to $75 billion a month, most investors probably thought the stock market would tank. And in fact, it did - for exactly one minute.

Yep, that's right; the minute after the statement was released, the S&P 500 plunged from about 1780 to 1768. The algos saw the word "taper" and did what they were programmed to do - sell, quickly.

The Algos Got It Wrong (Again)

However, the next minute the market spiked higher. And in the ensuing 7 minutes, the S&P soared from 1768 to 1795, a move of 1.5 percent. So, in 8 minutes, the algos moved S&P 500 39 points. What the heck?

Turns out that there was more to the FOMC statement than the taper. Obviously the taper announcement was bad. But the rest of the story was actually better than almost anyone had imagined. And it turns out that traders and their algos liked it - a lot!

The Press Really Got It Wrong (Again)

The headlines read, "Stocks soar on Fed Taper." Uh, no. Stocks tanked on the taper.

But, what the popular press didn't seem to get was the fact that the FOMC had basically said that ZIRP will stick around longer than expected and that inflation is now the key thing the Fed is concerned with - not employment.

So, in essence, Ben Bernanke was trading a "taper light" for an extension of the Zero Interest Rate period. This meant that monetary policy was actually going to stay easy LONGER than had been anticipated. Oh, and it also appeared that Bernanke was changing the trigger for future rate increases more toward inflation.

See also: How to Start an Investment Plan for 2014

Here's the actual line from the FOMC statement: "The Committee now anticipates...that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal."

So, as long as inflation remains under 2 percent, the Fed now appears to have cover to keep rates at zero. Boom-shakalaka!

The new emphasis on inflation is big. Why? Because, if one digs into the guts of CPI, they will find that wage inflation is what really drives up the official rate of inflation. And anyone who works for a living knows that there aren't a lot of raises being tossed around these days. As such, unless the job market picks up in a big way, rates can likely stay low longer by focusing on inflation.

What Mr. Bernanke is really saying is that the Unemployment Rate isn't telling the true story of the jobs market.

So, by shifting the focus to inflation, the Fed can continue to lend a hand until the much sought after "escape velocity" is actually reached.

So, what did we learn from Mr. Bernanke's last go round? In short, that ZIRP is more important than "the taper." And since low rates - especially uber-low rates - are good for stocks and may be around for quite some time yet, stocks celebrated. Well, okay, the algos took out the shorts and then the trend following algos piled on. But regardless of the reason, the key is anyone long stocks yesterday probably enjoyed the ride.

Click here to receive the full report each morning before the opening bell.

Tags: zero interest rate policy

Posted in: Broad U.S. Equity ETFs Federal Reserve Markets Trading Ideas ETFs