Dovish Fed whipsaws markets

Stocks surged, bond yields fell and the dollar crumpled as the Fed sent an unexpectedly dovish message to markets, shaving the pace of anticipated rate hikes and warning that the economy still has issues.

"The key takeaway, the main and most obvious one is they took down their expectations for fed funds at the end of each of the next couple of years," said David Ader, chief Treasury strategist at CRT Capital.

The Fed has indicated it will raise rates with the removal of the word "patient" from its statement, but it is also signaling it is not in a hurry to continue raising them. Besides downgrading rate increases, the central bank affirmed it expects inflation to ultimately reach 2 percent but it cut its near-term forecast.

Market expectations for the timing of the first hike in the fed funds rate also moved. Many economists had expected a June liftoff date, but more had expected September. The fed funds futures suggest the odds of a first hike in October have increased.

"They pushed out the timing of the hike to September," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi.

"No one's thinking June now. I can guarantee economists will drop June. ... It just doesn't add up with the forecast," he said.

The dollar's move was dramatic, falling the most intraday since March, 2009. The dollar index was down nearly 3 percent after the 2 p.m. ET statement.

"It's natural for the dollar to pause. The dollar was overbought. It had one of the most vertical moves in 40-years," said Boris Schlossberg, partner with BK Asset Management. He and other strategists expect the dollar to correct in the near term before rising again.

"I don't think the dollar rally is over by any stretch of the imagination. I think the market is going to be more data dependent...Now the Fed has taken away the promise of rate hikes, the market may be more two-sided for the time being."

That helped boost crude oil and gold futures. West Texas Intermediate futures reversed losses, trading at $44.97 per barrel, up more than 3 percent in late trading. Gold futures were up 2.1 percent at $1,172 per ounce.

Treasurys were big movers, particularly at the shorter end of the curve—most sensitive to interest rate moves. The two-year yield fell to 0.54 percent from 0.67 percent before the Fed release, and the five-year dropped to 1.38 percent from 1.54 percent. The 10-year yield fell below 2 percent, to 1.91 percent.

The Fed cut its 2015 outlook for inflation—to 0.6 to 0.8 percent—well below the 1 to 1.6 percent expected in December. The central bank also suggested that energy prices could be a factor that is not just fleeting, Ader said.

Traders were seemingly caught offsides, with many expecting a more a hawkish Fed. The stock market, negative before the announcement, turned positive with the Dow up triple digits, a 350-plus point swing. The Dow ended the day at 18,076, a gain of 227, and the S&P 500 was up 25 at 2099.

Fed officials moved from their midrange expectation of a 1.215 percent interest rate by the end of the year, to half that. The central bank's dot plot chart, which contains individual Fed official forecasts, also showed a trajectory of lower rates through 2017.

"I don't think it changes the market expectations. It brings the Fed more in line with what the market figured out," said Scott Clemons, Brown Brothers Harriman's chief investment strategist. Clemons said he expects the first hike in September.

Fed Chair Janet Yellen, in her comments, said June could not be ruled out for the first rate increase, but she said it will depend on the labor market and inflation.

The Fed, in its statement, added that suggests that "economic growth has moderated somewhat" since its January meeting. It also pointed to lower export growth.