As Gently As They Could

Tuesday we suggested that if the Fed were impolitic in announcing the end of the massive liquidity they have unleashed on the market in so many forms it could end the streak of unusually uneventful FOMC announcement days and disturb the market’s uptrend. Wednesday the Fed was as delicate as they could be in delivering the news but the market got the message and didn’t like it one bit.

The Fed announced what Chairman Bernanke had previously mentioned almost as an aside: the recession is over. And while it reassured the market that interest rates would remain at “exceptionally low levels…for an extended period,” it also made it clear that the extraordinary quantitative easing is likely to cease in the foreseeable future. Last month the Fed extended their purchase of Treasury bonds through the end of October. That date was not extended further. And while the purchase of agency debt and MBS were extended through the first quarter of 2010 this was done only to accommodate a slowing of activity in these sectors. The program will terminate by that date.

Profit taking ensued into the close as the market now understands that the liquidity floodgates will begin to close, however slowly, as we move forward. The dollar firmed up and inflation plays got hit.

The Fed could have been far more hawkish. For example there was no mention of draining liquidity as had been reported by Bloomberg late Tuesday. When the market has time to reflect we expect that any correction will be short lived. The Fed went to great lengths to point out that it will continue to be supportive of recovery.

The true test of how bullish the market will remain will be today’s performance. Very strong markets correct for all of a day or a bit more. Most important will be the action of winning stocks. Many held up well yesterday. Continued ballast in these market leaders, even in the face of a weak market, will be a signal to stay the course.