The Federal Reserve’s Federal Open Markets Committee (FOMC) shook up the markets with its statement on Tuesday that it would likely keep rates exceptionally low through mid-2013. This prompted three dissenting votes, which may have had more to do with the volatile reaction than the actual announcement. However, the announcement is pretty remarkable.

The Fed is telling us that it will maintain a zero interest rate policy—the same emergency policy that has been with us since December 2008 — for nearly two more years. 

Fed Fund futures had only priced in a 25 basis point increase in its June 2013 contract prior to the announcement so this shouldn’t have been than much of a shock. But I have to admit it shocked me.

Perhaps if they announced a third round of quantitative easing (QE3) it would have seemed too much of a reaction to the recent Standard & Poor’s downgrade of U.S. credit. And the market doesn’t seem afraid of U.S. credit as 10-year Treasury note futures rallied to all time highs (record low yields) so there is no immediate need for the Fed to starting buying up more Treasuries (see chart below). But it needed to acknowledge the recent weakness in the economy and at least appear to be taking some action.

It did, however, leave the door open for QE3: “The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.  It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.”

We have been critical of the Fed who have appeared to be talking out of both sides of its mouth during this crisis. At one point claiming the economy is improving and at the same time keeping rates at zero.

There was no confusion here as the outlook was grim.

More confusing is the market’s reaction. Equities where on their way to a pretty strong rebound when the announcement caused equities to tank to new lows. Then just as quickly they rebounded to close on their highs.

While this type of whipsaw reaction is seen during Fed auctions, the results of which are sometimes hard to read, their statement was pretty straight forward. It was either good news or bad news. I began wondering if conspiracy theorists would start to bring up the mysterious, “Plunge Protection Team”.

The market reaction was so weird it caused Andrew Wilkinson to write today: “The equity market’s strongest rally in several years is about as misplaced as had parents thrown a celebratory party for an eighth-grader after hearing their child would spend the next two years at the same grade level.”

I think Andrew is looking at the whole more than the parts. Remember the initial reaction was extremely negative. What happened next is a mystery to me as well, though I think it is related to the perma-bull mentality that is still rampant in the equity brokerage world. The internet was full of analysis from this space claiming we are at an historic buying opportunity. And yesterday’s S&P low represented a 20% drop in the index over one month. Surely the market was oversold and there is a portion of the investing world looking to buy a major bottom, and every serious downturn produces claims that this is a major bottom. Also, whether or not you subscribe to the PPT conspiracy theory, there is ample proof that the Fed will take action to attempt to prop up equity markets.

There have been numerous comparisons about what is going on in the U.S. economy with the Japanese lost decade (now decades). With the projection of a five-year period of zero interest rates, no time has that comparison been more apt.