By Anthony Mirhaydari
The nervousness was palpable as the Federal Reserve's taper/no taper announcement approached. And as the verdict was released — a $10 billion taper, but a promise to hold short-term rates low as the unemployment rate falls below 6.5% — you can be sure that there wasn't an occupied bathroom stall on Wall Street.
Everyone was glued to their terminals. Everyone was waiting for the market to render its verdict.
The funny business started a few minutes early, as precious metals inexplicably surged higher. Taper off, gold and silver suggested. Then the announcement crossed the headlines, taper on. Metals dumped. Stocks dumped. Bonds dumped. Volatility spiked. The taper was a bad surprise.
Then, in a span of minutes, an epic reversal. The Dow Jones Industrial Average gained 250 points and crossed back over the 16,000 threshold. Treasury bonds surged. Precious metals stabilized. Volatility dumped (counterintuitive, but it trades as a risk off proxy). Maybe the taper isn't so bad.
Then, the melt up into the closing bell pushes the Dow to a new all-time high. Maybe the Fed should've just cancelled QE3 all together by this logic.
Yet I'm skeptical of this initial reaction to a Fed policy announcement. Give the market a day or two to settle before reaching a verdict. In the end, I believe this bounce will fade.
For one, first reactions to major Fed policy announcements are often head fakes. The September surprise no-taper decision also smashed stocks to new record highs before a two-month-long pullback cropped nearly 1,000 points, or more than 6%, off the Dow. And in September 2012, when QE3 was first announced, stocks raced to new highs on the announcement before falling nearly 9% over three months.
Two, the true catalyst for the day's rebound seems to be in the currency markets where the all-powerful yen-carry trade got a huge lift from the rise in the dollar. If the market was really viewing today's actions as dovish — in that the drop in forward guidance in short-term rates was more powerful than the $10 billion taper — then the dollar should've weakened. Instead, the yen carry as represented by the ProShares UltraShort Yen /zigman2/quotes/208659456/composite YCS -0.21% surged out of a three-week trading range.
And three, I don't think the easing of forward guidance language will as great an impact as the liquidity junkies would like to believe.
The government's JOLTS data suggest the job market is further along in the healing process than is commonly believed. Consequently, a growing share of companies are reporting a harder time finding qualified applications, are increasingly looking at pay raises, and are hoarding the laborers they have by culling layoffs. Given this, the pace of tapering could increase in coming months as the unemployment rate keeps falling. And I don't think we'll have to wait until 2015 to see our first rate hike.
In the end, a combination of less monetary-policy accommodation, the prospect of pinched margins, and a looming debt-ceiling fight in February are all concerns investors will slowly awaken to. But I think the real catalyst for a reversal of today's surge will come from an increase in long-term interest rates as Treasury bonds sell off to reflect the "taper on" dynamic in the currency and precious-metals markets.
Once the 10-year Treasury yield crosses back over 3%, as the iShares 20+ Year Treasury Bond ETF /zigman2/quotes/206026314/composite TLT +0.03% falls out of its recent trading range, the Fed's historic experiment in ultra-cheap money will truly come to an end. Then we'll see if the bulls are truly so confident in the outlook heading into 2014.