Fed holds rates tiger by the tail, for now…

The New Year has started and not much has changed. All through 2013 we heard of an impending "bond bubble," a "stock market bubble" and a Europe expected to fly apart at any moment. It sounded like a broken record. But what happens? Nothing. Why?

Good question. With regard to the stock market (CME:SPH14), I can't count the times I have heard that the NYSE margin debt is at a new record high and a major red flag. But nothing happens. The latest states that this level has been seen only twice before in 2000 and 2007 at market peaks. But is it that simple? Maybe not. I have noticed time and again that commentators single out those facts that support their view only. We are probably all a little guilty of that. But, like everything else, there is more than meets the eye. And the stock market continues to rally. How with the economy barely crawling along? After all, when corporations do well, they hire more people to sustain the growth. Right? And that is barely happening. And the Fed announced the start of tapering, which should have caused the stock market to sell off — but it rallied breaking out over the highs formed since 2000. Why?

We are in a different world than ever before and that means that different criteria could be calling the shots. Corporations are doing well not for the traditional reasons (selling more of their product) but because they have become more efficient. The stock market rallied after the Fed’s decision not because of the small tapering gesture, but because of Bernanke’s continued stand on lower interest rates. Why?

A good part of the stock market rally was created by the central banks of the world. We have seen a price appreciation of assets because of cheap money (low interest rates) rather than traditional economic reasons. The central banks have injected so much money into the system, removing any of it could cause an extreme reaction to say the least. And they know that. Keeping rates low is critical to sustaining this so called "appreciation" and is why Bernanke made it clear that rates will remain lower longer than previously announced. And that made the stock market rally. 

So you has to ask, are interest rates now (vs. traditional economic factors) key to the financial system and dictating the pace of it? It sure looks that way. To show how important rates are, at this point, if interest rates increased 1%, bond funds would lose $200 billion. The government interest costs are at a record low. If the interest rates increased from the current .25% low to 4%, it would cost our government an additional $34.3 trillion. Get the picture? So to put it bluntly, the Fed, has a real "tiger by the tail" and they dare not let go.

It appears the Fed has created a monster from the extent of artificial stimulus that has been applied. And they know it. In more normal times rising rates would not have the severe impact it would have today. Sooner or later that tiger is going to turn and bite the holder of its tail. Why? Historically the Fed can control interest rates only to a certain point and they then develop a life of their own.

So where does that leave us as we start 2014? Still waiting for the impending "bond bubble, "stock market bubble" and implosion of Europe. Sound familiar? Back to square one as we approach 2014. But maybe with more clarity.

About the Author
Judy Crawford

Judy Crawford is a senior broker at Zaner Group. Raised in rural Minnesota, Judy went to the University of Minnesota and received a BA Degree in language.  She specializes in technical analysis of the markets and write a market commentary entitled “Market Update” that is available to readers via email. Contact her at jcrawford@zaner.com.

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