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Fed sounds less aggressive than expected and less confident in long-term growth 

Key Points
  • The Fed's removal of the word 'accommodative' initially led some to believe the Fed would get to the end of its rate hiking sooner rather than later.
  • But Fed Chair Jerome Powell threw cold water on the market view that removal of the term accommodative signaled a shorter rate hiking cycle.
  • By late in the day, markets were focused on the Fed's views on longer term growth, and the fact it may not be lifted as much by fiscal stimulus as some believe.
Federal Reserve Board Chairman Jerome Powell testifies during a hearing before the Senate Banking, Housing and Urban Affairs Committee July 17, 2018 on Capitol Hill in Washington, DC.
Alex Wong | Getty Images

Stocks and bonds seesawed as investors parsed the Fed's message on Wednesday after Fed Chair Jerome Powell spoke to reporters.

The Federal Reserve raised interest rates, as expected, by a quarter point, raised its economic outlook for this year and next, and removed the reference in its statement that policy is 'accommodative.' These actions initially sent stocks and bonds higher.

But while it was expected the Fed would drop the word "accomodative" from its statement, there was not really agreement among market pros whether that move indicated an easier Fed or a more aggressive one.

Powell told reporters during the post-meeting briefing that the removal of the term didn't indicate any change in the path of rate hikes.

That tossed cold water on the market. Stocks gave up their gains, and the Dow Jones Industrial Average ended down 106 points at 26,385.

John Briggs, head of strategy at NatWest Markets, said the bond market was expecting a more aggressive, or hawkish, tone from the Fed and didn't get it.

"The initial reaction was because they took out the 'accommodative' line. That rallied the market...Then we saw a big fade in all of that and rates went back to unchanged," Briggs said. "Bigger picture, yields sold off 25 basis points in several weeks." Briggs added that some people were concerned the Fed would actually bump up its rate hiking plans, but it did not.

Tom Simons, chief money market economist at Jefferies, said the Fed didn't seem to change its message. "It's all along a continuum that's previously been out. To me it seems like the market is trying to figure out what direction it should go in, and the confusion stems from the fact that there's not really a change in the message from the Fed."

Michael Arone, the chief investment strategist at State Street Advisors, said the stock market's gains faded after Powell's dismissal of the language change as meaningful, and focused instead on how the Fed views the economy after the initial gains of fiscal stimulus.

"I think the reaction was that the removal of accomodative was a signal they were getting nearer the neutral rate," he said. "I think at the post meeting press conference, what they got was 'we've not really bought into this idea that growth will materialize once the affects of fiscal policy wear off.' I think that was a punch in the gut of the stock market."

Treasury yields, which move opposite prices, also dipped when Powell said the Fed doesn't see much in the way of inflation.

In their forecast, Fed officials collectively estimated GDP would rise 3.1 percent this year, up from a previous forecast of 2.8 percent. For 2019, they expect 2.5 percent, up 0.1 percentage point. But the Fed held its longer term expectation of growth steady at 1.8 percent.

"I think it's really what's being signaled through the 2021 growth and inflation forecast. Its showing that the Fed sees growth in 2021 decelerating to the long run level and it shows the unemployment rate increasing in 2021 . They're forecasting things to be slowing a little bit," said Mark Cabana, head of US short rate strategy at Bank of America Merrill Lynch. He said more Fed officials targets for rates was lower for 2020, but the median did not change.

"This is a committee that is less confident about the outlook in 2020 than we previously believed," he said.