X The Federal Reserve held its key interest rate steady on Wednesday, as expected, issuing a benign statement that should do little to dampen Wall Street's recently buoyant spirits.
The Dow Jones industrial average, S&P 500 index and Nasdaq composite extended modest losses slightly after the Fed announcement. The Nasdaq has led the way lower throughout the session after a mixed earnings report from Apple (AAPL). Bank of America (BAC) shares and Dow component JPMorgan Chase (JPM) edged higher. Both Bank of America and JPMorgan are consolidating modestly below their 50-day moving averages.
The status-quo Fed statement points to a June rate hike, though it won't be followed by a press conference from Chair Janet Yellen and leaves something of a gap between the Fed's stated intentions and slightly more dovish market expectations.
The Fed statement emphasized the continued strengthening in the labor market, while noting that slower growth in the first quarter was "likely to be transitory." The Fed also noted that business investment has stepped up. Inflation is nearing the central bank's 2% goal but core price gains eased in March.
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The only possibility of news — and the probability was low — was that the Fed would highlight its intention to begin scaling back its asset holdings by modifying its policy of reinvesting all maturing mortgage and Treasury bonds.
The minutes of the Fed's March meeting, which were released April 5, indicated that policymakers believed the time had nearly come to begin shrinking the central bank's bloated balance sheet, which would act as a monetary tightening.
"Most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the committee's reinvestment policy would likely be appropriate later this year."
But the Fed statement retained the same language, noting that committee members anticipated maintaining the same reinvestment policy "until normalization of the level of the federal funds rate is well underway."
The ongoing risk to markets is that the Fed's signals imply a somewhat faster pace of tightening than investors are expecting. Before Wednesday's announcement, markets already saw a 71% chance of a rate hike in June, according to the CME Group FedWatch tool. But a subsequent hike wasn't expected until at least December, when markets saw a 52% chance of an increase in the Fed's benchmark rate.
The Fed has indicated that policymakers don't want to raise rates and alter the investment policy at the same time, increasing the chances that markets will respond to the balance sheet reduction without a hitch. Combined with the Fed's signal that two more hikes can be expected this year, the implication is that committee members' preferred timetable includes "rate hikes in June and September, and the first step in the (Fed's) balance sheet normalization process in December," wrote Ward McCarthy, Jefferies' chief financial economist.
IBD'S TAKE: Just as Wall Street seems to be reining in its expectations for the economy, surging income and employment taxes are signaling that wage gains may have shifted into higher gear.
Wall Street has grown a bit less bullish about the economic outlook, given uncertainty about President Trump's fiscal policies and weaker readings on GDP growth in the first quarter and job growth in March. Yet the markets and the Fed may no longer quite be on the same page.
The Fed's belief is that the U.S. is already close to full employment and that higher wage growth, when it comes, is likely to flow through to higher inflation. Yellen has said that the longer-run trend in labor force growth is between 75,000 and 125,000 per month, so anything faster than that soaks up any remaining slack.
At some point, the divergence between Fed signals and market expectations will be resolved, possibly by the June 14 meeting.
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