Yesterday was the first trading day since the S&P downgraded their rating of US debt, due to the fiscal policy instability in our country. The instability stems from a complete inability to compromise on Capitol Hill. The left side of the aisle points their fingers at the right side, saying it's going to take both spending cuts and revenue increases to fix the problem that the right side won't listen to, and the right side of the aisle is throwing their hands in the air claiming a mandate from the Taxpayer to fix rampant spending abuse in Washington, then folding their arms and playing chicken with default. But ensuring true, longterm economic health is not an overnight fix, something both sides were looking for and stood firm on. Even with an analytical error, S&P was right to downgrade US debt, because there is a major structural issue to address.
That is a large part of what caused yesterday's massive selloff, taking the stock market under 11,000 and closer to Bear Market territory. The other major fundamental aspect to the economy that would let the air out of stocks is that it appears that QE has ended, and the debt deal hints that it wouldn't be prudent to inject any more liquidity into the markets, artificially inflating them. Therefore, the market is now right-sizing to what it would be sans intervention. Of course, today we had a pop-back in reaction to the Fed leaving rates low, but once that announcement gets fully digested, I think the market will interpret the statement as I did: You're on your own, now.
Today's Fed decision was to leave the target benchmark overnight interest rate between 0-0.25% until the middle of 2013. The bond market naturally went nuts over the news, as a 2-year T-Bill essentially became an overnight note. The stock market went schizophrenic, unable to decide whether all of the dire ajectives about the economy overshadowed the low-rate environment or not. The little engine that could (open-market LIBOR rates), however, has continued to chug along as it has for the last month in an upward direction.
So, based on the fact that 1) LIBOR is on a slow but consistent rising trend, 2) There were 3 dissenting FOMC members to today's statement, all which would have preferred to keep rates low for a shorter duration 3) The Fed has never set a target date horizon for a consistent rate level, leading me to believe that the decision, while probably an analyzed and educated estimate, is more of an emotional appeal to appease the market and rates may not in fact remain this low until 2013 -- We're in the full-swing of a US Treasury bubble, or an inverse bubble for rates. Market returns must out-pace inflation, and as mortgage rates get pushed under 4% again this week (just watch), investors will begin to again search out a predictable stream of income (i.e. dividend paying stocks, corporate bonds) that will provide a more reasonable investment return. Comparative risk appetite may increase in the mid-term, which should cause a demand decrease in US Treasuries and the subsequent and ineviable rise in yeilds. This is the slow and healthy process of the cyclical economy, and hopefully we're disciplined enough to accept this over a quick fix as we have in the past.
