Fed Chair Janet Yellen managed to appease doves interested in maintaining easy central bank policy, but gave slight encouragement to hawks who want to see an acknowledgement the Fed would raise rates sooner if necessary.
In what arguably was the most anticipated Fed speech of the summer, Yellen carefully constructed a picture of a still poorly functioning labor market that requires easy Fed policy. But she also said the economy is getting closer to the central bank's objectives, and the Fed is "naturally shifting" to the debate on when to raise rates.
The dollar firmed after Yellen's comments. Stocks initially rose, but were trading at lower levels in late morning trading as the market focused on Ukraine. The bond market reaction was most telling, with rates rising on the short end of the curve, and the two-year yield briefly touching 0.50 percent.
"This is her arguably taking a step to the middle," said Ian Lyngen, senior Treasury strategist at CRT Capital. "We do see an increase in Fed funds futures rates, and that's reflected in the two- and three-year sector in Treasurys, and it's consistent with the notion that we're continuing on the path of a rate increase in the middle of next year."
As Yellen made a case for the Fed's current easy policy, her comments on the potential for structural forces affecting the labor market got the most attention.
"Even though she sees evidence it could be structural, she still sees enough of a cyclical element that policy will continue to have a positive influence on the labor market," said Tom Simons, money market economist at Jefferies. "It's dovish, but no more dovish than I expected. ... There's some concern about the talk that they might have to raise rates before inflation justifies, but I think when you take the whole thing together, it's still pretty dovish."
The Fed earlier in the week released the minutes of its July meeting that took a more hawkish tone. The minutes said members were surprised by the improvements in the labor market and they discussed an earlier rate hike.
The economy has added more than 200,000 jobs in each of the last six months, and the unemployment rate, at 6.2 percent, is close to the Fed's projected rate of 6 to 6.1 percent by year-end. Economists expect the first Fed rate hikes in the middle of next year.
"She talks about how it's difficult to measure if it's cyclical or if there's a meaningful structural component," said Lyngen. "It's not hawkish or dovish per se. It does represent a shift. She had not been as vocal about the structural aspect of the increase in slack in the labor market."
Several of the more hawkish Fed officials have said the central bank should be discussing moving to normalization in rates now, but the dovish members don't expect a rate hike until later next year and they note a lack of wage inflation as a sign of continued labor slack.
Yellen has made it clear the Fed needs to maintain easy policy to address the concerns of long-term unemployment and a low labor market participation rate.
In the 10 a.m. ET speech, Yellen discussed the lingering concerns of low labor market participation and the large number of still part-time workers. "Some portion of the rise in involuntary part-time work may reflect structural rather than cyclical factors. For example, the ongoing shift in employment away from goods production and toward services, a sector which historically has used a greater portion of part-time workers, may be boosting the share of part-time jobs," Yellen said. She also mentioned a skills mismatch affecting hiring.
"It's an academic speech that gives no new clues or revelation about how they'll act, which tells me she's not pushing back on the minutes where more people were acknowledging that things are moving faster they they thought. We're back to where we were at 9:59," said Peter Boockvar, chief market analyst at Lindsey Group.
—By CNBC's Patti Domm