What Zero Interest Rates Means for Your Investments

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    NEWSLETTERS

    The Federal Reserve's move to cut interest rates to near zero may generate big headlines, but for most investors the focus remains largely elsewhere.

    While the decision Tuesday spurred a sharp rally on Wall Street, the market is looking at whether it will have a real impact on credit spreads and restore investor confidence.

    Market players already had been at least short-term bullish on stocks, and the consensus opinion was that the Fed move modestly improved that sentiment.

    "It's a small step in the bullish direction for equities," says Richard Sparks, senior analyst at Schaeffer's Investment Group in Cincinnati. "When you have the government making such a huge push to reinflate the economy, that should be a little bit of a tailwind for equities. We've still got a lot of work to be done."

    But questions remain over many aspects of the market and economy, and Fed move was predicted to have varying effects on the different asset classes.

    Stocks: Stoking the Rally

    With high hopes for a Santa Claus rally working hand-in-hand with enthusiasm over the coming of Barack Obama's presidency, equity traders were looking at a nice move into the end of the year and the beginning of 2009.

    The Fed reduction of its funds target rate from 1 percent to between 0.25 and zero helped the mood enough to boost the Dow industrials by 350 points Tuesday. But the market was mostly flat or lower through the day Wednesday.

    "To me it's not really clear that a rate cut is going to be terribly helpful at this point," says Gary M. Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles. "The Fed already lowered rates by almost 500 basis points this year and that hasn't been helpful, so what is cutting the last 75 basis points going to mean?"

    Financial stocks should benefit, says Flam, who is optimistic about 2009 and believes large-cap quality firms will be the best investment vehicles ahead.

    "The market is set up for a rally into year-end and possibly beyond, Fed news or not. I don't think (the Fed) gets in the way of that," he says. "You have a fight back and forth between the bulls and the bears and bulls are winning for now."

    But as far as Fed policy goes, investors are still taking a wait-and-see approach to what effect it will have on stocks.

    "To some degree we need to be cautious in terms of thinking that what happened yesterday is going to be a panacea," Sparks says. "It's going to be months out to see whether this and other things the Fed is planning to do will stave off the worst kind of recession."

    Bonds: Still a Bid for Safety

    While short-term Treasury yields have been pushed to near zero, and in some cases below, the uncertainty of the economy is likely to still see a drive towards Treasurys that will not be strongly abated even as the Fed moves push yields lower.

    "It's still a question of capital preservation," Jack Bouroudjian, chairman of Capital Markets Technologies, said on CNBC.

    Treasurys trading is likely to remain brisk until investors feel better about getting back into stocks.

    "For me the real question is what does this all mean for the appetite for risk and when will that return to the marketplace?" Bouroudjian said. "Yesterday's short-covering rally was a glimmer of hope" for stocks.

    See more of Bouroudjian's comments in video.

    But if the Fed cuts do help increase liquidity in the market, that would lead to investors eschewing bonds as 2009 progresses and increasing their exposure to equities.

    "There's tremendous opportunity to be adding to equity portfolios. Now is not the time to be running from stocks," Flam says. "We used the selloff in the fourth quarter to increase equity exposure for our clients."

    Don't Bet Against the Dollar

    The natural reaction from traders has been to run from the dollar in a rate-cutting environment that look likely to devalue the US currency.

    Those who do so may end up regretting it, according to one contrarian analyst.

    "We can’t reiterate enough that nothing has changed when it comes to measuring the performance of the economy," Andrew Wilkinson, senior market analyst at Interactive Brokers, said in a note to clients. "What has changed is the perception that the euro is a better place to be than the dollar. Simply put, it’s not."

    Instead, weakness in the overall economy will continue to drive demand for the dollar as goods get cheaper and increase buying power, he said.

    Still, Wilkinson noted that the early move has been weakened demand for the dollar on the rate cuts, a trend many investors are likely to follow until more bad news emerges for the economy.

    "The world’s largest economy is still in a huge mess," he wrote. "That’s a polite way of stating it. We see no positive data having emerged that instills confidence in a rebound. We would still argue that where the US is heading, the global economy is not far behind."

    In Commodities, Be a Metal-Head

    Both a continued push for safety and disparate views of what the future of the dollar will do has some betting on metals, particularly gold and silver.

    Both have been on a run lately, with some predicting that gold prices could soar past $1,000 and beyond as employment weakens and the economy falls, while at the same time the Fed seems to have little interest in propping up the dollar.

    "Gold and silver moved sharply higher and they're higher again" following the Fed cut, said Rick Pendergraft, market analyst at Investors Daily Edge newsletter. "That's a result of this inflationary action that we're seeing by the Treasury and Fed."

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    As with bonds, the safety play will continue to be a recurring theme in the days ahead, even as stocks move higher.

    "You're pushing all this money into the economy trying to push people to buy and buy and buy," Pendergraft says. "It's not just the devaluation of the dollar but it's also dumping all this money into the economy at once trying to generate all this activity."

    Housing: The Big Gainer?

    One of the most closely watched gauges of Fed impact will be on the housing market, which has suffered due to an unwillingness on the part of risk-averse lenders to provide mortgages.

    There was hope following the Fed move that the tumbling of mortgage rates--a 30-year fixed was at 5.53 percent Wednesday--would make it irresistible for buyers to buy and lenders to lend.

    "The real question is whether the rate that matters to people--namely mortgages--starts to come in," Bouroudjian says.

    Pendergraft is among those who thinks that at the very least, home builder stocks will be a good place to go as more qualified buyers come in and the companies cut inventory.

    "The ramifications of these historical cuts and the historically low interest rates are so widespread," he says. "It's going to impact every single sector in the economy and every single sector of the market."

    For more stories from CNBC, go to cnbc.com.