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Federal Reserve Decision: Hawkish Or Just Pragmatic?

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Federal Reserve Decision: Hawkish Or Just Pragmatic?

As expected, Janet Yellen's Fed announced on Wednesday that their QE bond-buying program was coming to an end.

The move was widely telegraphed and could be viewed as a positive since the Fed no longer thinks the economy is weak enough to require the Fed's help.

To support the relatively upbeat view of the economy, the statement released by the FOMC led off with an acknowledgement of the improvement in the jobs market. Specifically the Fed wrote, "Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate."

In addition, the FOMC statement said that "a range of labor market indicators suggests that under-utilization of labor resources is gradually diminishing." In Fed-speak, this too was considered an upgrade to the labor market.

Remember, the Fed has what is called a "dual mandate," meaning that they really have two jobs: full employment (i.e. the unemployment rate) and price stability (inflation). One key takeaway from the Fed statement on Wednesday is that the Fed believes it is getting somewhere on the first goal.

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The FOMC basically said as much via the line in the statement that read, "The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program."

What's The Problem?

Stocks initially sold off on the release of the Fed's statement. Although a late rally kept the losses to a minimum, futures then immediately retreated after the close and are pointing lower again in the early going today.

So, what gives? Why would stocks move lower in response to the Fed saying things are looking up?

The key to the current pullback appears to be fairly straightforward. You see, the fast money masters of the universe have decreed that the FOMC statement was "more hawkish" than had been expected. Remember, Wall Street does not like surprises -- especially coming from the Fed.

In English, the takeaway from the FOMC statement is that the Fed may need to turn from being "dovish" toward the economy (i.e., lending a stimulative hand) to being more "hawkish" on the inflation front (making sure that inflation stays at or below their 2 percent target). If the latter is the case, then the fear is that rates will need to begin to rise sooner than currently anticipated.

Apparently, traders had expected another warm and fuzzy statement from Ms. Yellen's bunch. Given that Fed Governors such as James Bullard, who tends to lean toward being an inflation hawk, had recently stated that the Fed could delay the end of QE or even do more if the economy shows signs of weakness, traders expected the FOMC statement to show more concern about the potential downside risks stemming from Europe.

Although Ms. Yellen's gang of central bankers did say that rates would remain at their current levels for a "considerable time," the real key here is the view that the Fed became "incrementally more hawkish" with yesterday's statement.

It's All About Inflation Now

Perhaps the key takeaway from the Fed's statement is that the committee's focus is now squarely on inflation. As such, the most important line in the statement was, "Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year."

While this language sounds tame enough, traders took it to mean that the Fed may be more concerned about inflation than they have been. As a result, rates may need to rise sooner than the street currently expects.

On the topic of rates, the Fed's statement made it clear that the FOMC will remain "data dependent." If one reads the entire statement they will probably come away with something along the lines of, "Okay, that makes sense."

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Cutting to the chase, the Fed is saying that they want to err on the side of caution and keep rates low for a "considerable time." They are also saying "Hey, if the economy and/or inflation expectations start to heat up, we're going to have to do our jobs and take some action." Which, to those with an objective view, would seem to be logical.

One More Thing

If you are still wondering why traders and their computers might see any of this as being negative, there is one more thing to keep in mind at this stage of the game. Lest we forget, the market has run an awfully long way in a very short period of time.

As the chart below shows, there is now important resistance overhead as the S&P approaches its all-time highs.

S&P 500 (NYSE: SPY) - Daily

spx_daily_10.29.14.png

In light of the fact that the S&P had popped up 9 percent in nine days off the intraday low, with much of the gain fueled by Fed-speak both at home and across the pond, a period of backing and filling is probably in order until traders can figure out whether or not the improvement in the economy is a good thing.

Tags: FOMC James Bullard Janet Yellen

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