Fed expresses caution for this year, optimism for next
Markets seesaw following afternoon announcement
The Fed’s 2 pm announcement was cautious in the short term (three interest rate increases for 2018 of 25 bps each rather than four as some analysts expected), but a more aggressive forecast for 2019 (higher inflation and growth forecasts, and a higher future target for federal funds). In his first meeting as Fed Chairman, Jerome Powell decided to have his cake and eat it, too: He sounds upbeat, tough, and hawkish about next year but cautious about this year.
Markets gyrated in the first minutes after the announcement as traders tried to make sense of the announcement. The Fed declared that inflation would rise to the Fed’s 2% target in 2019 and that employment gains would remain strong. At 2:08 pm, the dollar was a bit weaker, bond yields were virtually unchanged (slightly higher for the 10-year and slightly lower for the 30-year), and stock prices were strongly higher (with the Dow Jones Industrial Average up 200 points, led by financials). By 2:40 stocks had pared gains, falling to around the same level as at the time of the Fed’s announcement.
The stock market will likely take comfort in the story because the Fed won’t do anything hasty or disruptive during the present year, and stock investors have learned not to take seriously anything the Fed might say about next year. In particular, the Fed has been dead wrong about inflation for the past several years. Interest rate options traded with lower implied volatility, suggesting that the Powell Fed achieved exactly what it wanted to: it stabilized market expectations while sounding upbeat about growth and ready to raise rates if necessary.