Slightly less dovish Fed sends ripple through markets

A trader works on the floor of the New York Stock Exchange.
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A trader works on the floor of the New York Stock Exchange.

The Fed signaled it will keep its easing programs in place, but markets were spooked by a tone that sounded slightly less dovish than some traders expected.

Following its two-day meeting, the Fed said in its statement that it would continue with its $85 billion monthly purchases of Treasury and mortgage securities, as expected. But the Fed eliminated some language in its statement, including its concern about a tightening of financial conditions, a reason it cited for maintaining its easing program in September.

The Fed also removed comments about higher mortgage rates, and it did not sound as negative on the economy as some Fed watchers were expecting.

Stocks sold off and Treasury yields zipped higher, while the dollar also moved higher. Stocks were lower going into the statement, and yields were lower. The the Dow sold off more than 100 points before recovering, and the 10-year Treasury yield moved from 2.48 percent before the 2 p.m. ET statement to a high of 2.54 percent after it.

"We've had this rally basically from mid-September's 'no taper' statement to now, where they reinforced the fact tapering is deferred and now the market sells off," said Mark Luschini, chief investment strategist at Janney Montgomery.

Both the Dow and S&P 500 rose to record highs in morning trading, before selling off into the Fed statement. The Dow ended the day at 15,618, off 61 points, and the S&P 500 was off 8 at 1763.

Luschini said the market is now digesting a possibility that the Fed pulled forward the timing of tapering. After the 16-day government shutdown, many Fed watchers moved their expectations for tapering to March, due to uncertainty about the economy.

(Read more: Bad month for jobs)

"The Fed didn't acknowledge a suspected weakening in the economic data," Luschini said. "I am assuming the market is interpreting that there could be tapering in December, January or March." He said January would be more likely than December since the Fed would not want to rattle markets during the holiday shopping season.

"It was ever-so-slightly less dovish, and people thought it would be more dovish," said Ward McCarthy, chief financial economist at Jefferies.. "They removed the reference to the increase in mortgage rates and they removed financial conditions." The Fed did, however, say it was still concerned about the housing recovery.

David Ader, chief Treasury strategist at CRT Capital, pointed to a change in market expectations apparent in Fed funds futures. "If you look at November 2015 Fed funds futures, we peaked out at 138 basis points at the beginning of September, and now it's 59 basis points. That 's dramatic," he said.

(Read more: CPI tame in September; helps Fed)

"The market has corrected to a level where the Fed no longer thinks interest rates are a stress for the economy. They did in September. They don't now," he said.

McCarthy said he expects the 10-year Treasury yield to mostly stay in a range now between 2.50 and 2.58 percent, unlike September when it was testing the 3 percent level.

"We still don't really know where the economy sits, and we have no idea at all where fiscal policy sits. The path of least resistance could be lower rates in the short-term," McCarthy said.

The Fed did not specifically refer to the government shutdown and its impact on the economic data, some of which is still delayed, and also expected to be murky for several months. Wednesday's ADP data showed a decline in private sector hiring, with just 130,000 jobs in October. The delayed government jobs report is expected Nov. 8.

"They pretty much said what they said last time. It was a little more cheerful than I expected," said Brad McMillan, chief investment officer for Commonwealth Financial. "It was notable for what it didn't talk about. The shutdown, the debt ceiling negotiations. This is the elephant in the room. This in my belief is why they didn't taper at the last meeting."

(Read more: Taper tease? Market worries Fed will end easing)

Kathy Jones, fixed income strategist at Charles Schwab, said she still expects the Fed to wait until the March meeting, which would be the first chaired by Fed Vice Chair Janet Yellen, who was nominated by President Obama to replace Fed Chairman Ben Bernanke.

"This is them being cautious and saying we're standing pat right now," she said. "It'd be really tough to make a move here. They don't have good economic data…It would really be kind of odd for them to have done anything."

Markets enter the final day of October trading, with solid gains for a month that is seen as typically among the worst. The Dow is up 3.2 percent, and the S&P is up 4.9 percent.

Strategists, while noting a number of red flags, say there's now a good chance the market could be carried higher into year end.

"I think at this point everyone has baked in that we're going to get up to the end of the year, so people are buying into that," said McMillan. "...the market is up so much who wants to be out of the party?"

The market is being supported by the Fed but is also going up while future earnings may prove to be too weak to ultimately support it, McMillan said. He said the market has been setting up for a sell off.

"I think it's overvalued. We're overdue for a significant one," he said. "That said, I don't think that's necessarily going to happen."

There is some data to watch Thursday and plenty of earnings. Weekly jobless claims are released at 8:30 a.m., and Chicago PMI is expected at 9:45 a.m. Earnings expected before the open include Exxon Mobil, MasterCard, Royal Dutch Shell, Avon Products, Cigna, Clorox, Discovery Communication and Time Warner Cable. AIG, Newmont Mining, First Solar, Northeast Utilities, Public Storage and Fluor report after the close.

—By CNBC's Patti Domm. Follow here on Twitter @pattidomm.