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As market commentators were endlessly debating when the Fed will taper and by how much, the market had been ignoring pundits and carrying on as it usually does .. discounting the future.

If you had not noticed, markets were not falling before yesterday's Fed announcement. In fact, markets were going higher on a daily basis. Does this mean that Fed tapering will not affect markets? No, Fed tapering it will affect markets and the economy, but it will happen over a long term period and it will not happen today. Even if the Fed had announced a reduction in assets purchases, the amount would have been miniscule and markets were well prepared. And just as the Fed did not reach the point of buying $85 in assets a month in one day, it will unwind over a long period of time.

However, the fact of the matter remains that the unwinding of asset sales will happen. It might happen in the future, but it will happen. And this will be a drag on the market, even if today we had a rally.

For example, right now housing is strong. People are buying houses and house builders are doing just fine. However one has to take into account the issue of interest rates. When the Fed begins to lower its monthly asset purchases (at some point in the future), interest rates will go higher. In fact they have been going higher and the Fed has not even begun to taper.


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Currently a conventional 30 year mortgage stands at 4.46%. While this is not as high as several years ago, it is nevertheless about 100 basis points higher than it was several months ago. How high rates might go no one really knows. Ηowever, since housing is a function (to a great extent) of mortgage rates, it is only natural that housing will hit a speed bump when rates reach 5.5 - 6.5 %, if not sooner.

As a result, housing stocks such as Toll Brothers (NYSE:TOL), Lennar (NYSE:LEN) and DR Horton (NYSE:DHI) have been very hesitant the last several months and have gone nowhere. Today however they are rallying on the news that the Fed will put Tapering off, awaiting further evidence of a stronger U.S. economy.

But this does not change the fact that tapering will happen. As a result, and because markets are forward looking, interest rates will continue to be a major headwind for housing, even if the Fed put off tapering for the time being.

Another sector that is very interest rate sensitive is the auto sector. And just like housing, there have been plenty of cars sold lately as a result of very low interest rates. Like I said in a recent article, General Motors (NYSE:GM) and Ford (NYSE:F) are a sell based on this, because interest rates will be a headwind for the sector. And while both stocks might not crash, they will not make you money from now on either.

The Fed employs a lot of smart people. I think Ben Bernanke took out some insurance when he decided to keep assets purchases as is. I don't know if he made the correct decision or not, but what I can tell you is that the longer these asset purchases continue, the more the market will be out of sync with the element of risk. And getting back in sync with reality in the future will not be an easy thing to do, when for years and years you have been use to having a money poured in the market as a safety net.

And while I do believe that the Fed understands this more than me, I also think they are not sure what will happen either, when they decide to pull the plug on the markets drug (asset purchases).

Either way, an across the board increase in interest rates will affect the economy and the market. Whether the Fed can orchestrate a soft landing remains to be seen, but the fact that they delayed the inevitable yesterday, might be a sign that they are not sure, or that they cannot orchestrate a soft market landing. And to me that smells trouble.

Source: Taper Or No Taper, The Market Is On Borrowed Time