The Federal Reserve sent an unexpected message to the markets Tuesday: We'll keep interest rates low as long as you want, but outside of that you're on your own.
With investors anticipating a strong central bank reaction to a brutal August, the Fed instead noted the weak economybut said virtually nothing about the markets—no quantitative easing, no yield curve flattening, no Troubled Asset Relief Program or any facsimile thereof.
While the reaction of traders was manic—violent swings to both sides immediately following the announcement—some were ready for the Fed and Chairman Ben Bernanke to cut the apron strings.
The end result for the day: A dizzying 624-point Dow rally in the last hour and 15 minutes to send the bluechip index up 4 percent.
"Since the 2008 crisis we've developed this thought that if we crash they'll spend $740 billion TARPs on you, they'll keep dropping rates on you. That's an unhealthy environment for investors," said James Paulsen, chief market strategist at Wells Capital Management in Minneapolis. "To the extent that they're getting away from that and saying, 'stand on your own,' that's a very healthy event for today."
That message, though, only seemed to confuse the markets further.
Trading was highly volatile, with the biggest winner being gold, which surged toward $1,750 an ounce. The stock market swung to and fro, giving up a strong rally earlier in the day then pushing higher to the close as investors tried to parse what the developments would mean for the market.
"I applaud the Fed's move because they didn't do Congress's job. They said, 'We will keep rates low for the next two years, now Congress, come back and institute fiscal spending discipline and pro-growth economic policies,'" said Doug Cote, chief market strategist at ING Investment Management in New York. "The private economy now has assured low rates for the next two years and that...makes equities that much more attractive."
Indeed, the main new development from the meeting was the perhaps unprecedented step of saying that rates would be kept near zero until mid-2013.
That language came along with a dour outlook for the economy. In the opening paragraphs of the statement, the FOMC uses "weak," "depressed" and "downside risks" to describe conditions that it acknowledged were worse than central bankers expected them to be.
"I would have liked to see them give more lip service to things that are a little better than expected," Paulsen said. "Last week I saw the second outperforming ADP (private jobs report) in a row, another outperforming weekly payrolls number and a better monthly payrolls number. There are some things suggesting a bounce happening and I'd like to see our leaders, particularly our monetary leader, talk about that."
The statement, though, mostly stuck to a narrative about challenging economic conditionsfor which there seemed to be limited monetary solutions. Instead, the report focused on the problems the economy is facing and the Fed's likelihood to keep rates near zero.
"They again boxed themselves into a corner where they are going to keep interest rates where they are for the next year and a half," said Brad Sorensen, director of market and sector analysis at Charles Schwab in San Francisco. "That's something the Fed shouldn't do. They should keep their flexibility."
Commodities markets showed a mixed reaction to the statement. Gold rallied but oil fell and grains were split, indicating that the commodities markets.
"Some of the markets may have overreacted a bit. Needless to say there will be less consumption throughout the world than we had seen in 2010," said Shelley Goldberg, director of resources and commodities strategy at Roubini Global Economics in New York. "You're going to see a hiatus in surging commodities prices overall."
The confusion in markets, in fact, seemed to reflect a confusion at the Fed over the direction of the economy, Sorensen said.
"They seem a little confused as to why the economy hasn't grown faster," he said. "They don't know how to address that."