When the Fed voted to hike interest rates, the market reaction saw stocks rise, bond yields fall and the U.S. dollar decline against its global peers. That, according to Goldman Sachs, was pretty much precisely the wrong reaction.
After all, the U.S. central bank, by increasing its benchmark rate, was trying to tighten up things at least a little.
Instead, a measure Goldman uses to gauge financial conditions actually loosened afterward. The upshot: Investors may be underestimating how quickly the Fed will move in the future.
"We feel quite confident that they were not aiming for a large easing in financial conditions," Jan Hatzius, Goldman's chief U.S. economist, said in a note to clients. "After all, the primary point of hiking rates is to tighten financial conditions, perhaps not suddenly but at least gradually over time."
Fed officials did reiterate that they are keeping a gradualist approach to policy, with no preset course on the way back to a normalization of rates. Consequently, the term "dovish hike" gained popularity as the Federal Open Market Committee's decision, and accompanying language and economic projections, appeared not as aggressive as some market participants had feared.
Still, the reaction seemed outsized across financial markets at a time when monetary policy will be getting more restrictive, not less.
Goldman's proprietary financial conditions index showed a 0.14 percentage point easing after the FOMC decision came out at 2 p.m. Wednesday. For perspective, Hatzius said that kind of move would be the historical equivalent of a quarter-point cut in the funds rate rather than an increase.
Here's a visual for how Goldman's FCI has moved over the last nine months or so:
The direction of financial conditions is no small matter for the Fed. The measures basically take into account government debt yields and spreads in bond rates, along with stock market prices and moves in currencies, measured against economic growth projections. The Chicago Fed has its own FCI but it has not been updated since Wednesday's decision.