More market reaction to FOMC

Let's start here. The headline is "Stocks, Bonds Fall, Dollar Firms."

How often does that happen? The article reads...

NEW YORK (Reuters) - U.S. stocks and bonds fell and the dollar firmed on Tuesday after the Federal Reserve said inflation picked up recently, indicating to traders that the pace of interest-rate hikes could quicken in the months ahead.

As expected, the Fed raised rates by a quarter-point for the seventh straight time and maintained its "measured pace" language regarding future increases.

But what got investors' attention in the Fed's accompanying statement was that pricing power was increasing in the world's biggest economy.

Stocks reversed course and went negative.

The Dow Jones industrial average was down 45 points, or 0.43 percent, at 10,520. The Standard & Poor's 500 Index was down 5 points, or 0.46 percent, at 1,178. The Nasdaq Composite Index was down 10 points, or 0.50 percent, at 1,998.

"The Federal Reserve said it was going to continue raising rates at a measured pace while acknowledging that inflation is starting to edge higher," said Michael Sheldon, chief market strategist at New York brokerage Spencer Clarke.

"The reason the stock market gave up its gains following the Fed meeting is because some investors are seeing through the Fed's gentle phrasing and are realizing that the Fed is starting to become more serious about fighting inflation."

Tell that to the bond market...

The yield on the benchmark U.S. Treasury 10-year note rose to its highest level in eight months.

"Instead of dropping 'measured,' they chose language that acknowledges the modest pickup in inflation pressures," said William Fitzgerald, head of fixed-income portfolio investment at Nuveen. "This may be a step toward getting rid of 'measured,' of being more aggressive without indicating a change in the plan."

Remember what I said yesterday about the word "measured" taking on a life of its own? Apparently now we need to take gradual steps to remove that word. And "being more aggressive without indicating a change in the plan"? That's the kind of answer you give when you've just been blindsided.

The yields on the 10-year Treasury note shot up as high as 4.62 percent from 4.48 percent just before the Fed release and 4.52 percent late on Monday. The yield on the two-year note rose to 3.75 percent from 3.72 percent.

So you're trying to tell me that stocks fell because the Fed is going to get tough on inflaton, and bonds fell because the Fed is not being tough enough on inflation. The choice of words managed to give everyone something to complain about. Leaving in the word "measured" while acknowledging inflation was not what people wanted to hear.

So how about some good news?

The euro initially slipped half a cent to session lows around $1.3146, according to Reuters data, from around $1.3200 shortly before the Fed announcement, and down about 0.2 percent from levels late on Monday in New York.

Against the yen, the dollar rose to 105.23 yen, up from around 105.07 yen shortly before the announcement.

What gives? CNN thinks it knows...

Higher rates makes U.S. securities more attractive to foreign investors, who must purchase the notes in U.S. currency.

The dollar has gained more than 2 percent against the euro and yen since the start of the year as investors bet that rising interest rates and higher yields on dollar assets might help offset worries about structural problems in the U.S. economy, including the nation's massive deficits.

I dunno... it didn't look like foreign investors were scrambling for dollars so they could rush out and buy stocks and bonds this afternoon. It would seem more likely to me that the exchange market is just reserving judgement and waiting until tomorrow's CPI data comes out. The CPI data will either be a reassurance to the bond market or the other shoe dropping on bonds and the dollar. I guess we'll have to wait until morning.

Greg Ip reminds us that the decision of how to word this press release was frought with difficulty. (WSJ subscription required)

Some officials feel that inflation risks have risen, so the Fed should give itself more flexibility in how it responds to incoming economic data, with a half point move if necessary. But other officials believe communicating their limits disruptive volatility in the markets, and they should continue to say rate increases will be measured as long as Fed officials really expect that.

The last sentence looks like a typo, but I think you and I know what he's saying.

Fed chairman Alan Greenspan fueled speculation that "measured" would be dropped when he declined to use the word in his testimony in mid-February to Congress. But he did question why long-term interest rates in the bond market are so low, calling them a "conundrum."

And Mr. Ip knows who to go to for a quote. Clarida is a fine economist who seems to come closest to explaining what happened.

Richard Clarida, economic strategist at Clinton Group, a New York hedge fund, says when the Fed tightens credit conditions, it relies on the bond market to do some of its work by boosting long-term borrowing costs. The fact that, up to this point, it had not left Mr. Greenspan two options: drop "measured" and raise short-term rates faster, or use the "bully pulpit" of his congressional testimony to push long-term bond rates higher. Since bond yields rose sharply after Mr. Greenspan's testimony, Mr. Clarida says the Fed concluded it can stick with "measured" rate changes for now.

But still I'm not sure. If the CPI doesn't take too big of a jump and the bond market calms down, then maybe it's ok to leave the word "measured" in. But if the CPI is higher than expected tomorrow, then long term rates go even higher--in part because the word "measured" is still in.

Of course, if Clarida is right, then that's just what the Maestro ordered.

One last thing from Ip's article.

The Fed also raised the rate on the less important discount rate, charged on short-term Fed loans to commercial banks, to 3.75% from 3.5%. Just 10 of the Fed's 12 reserve banks requested the increase in the discount rate. It was unclear why the Kansas City and Dallas banks did not.

I'm sure that K.C. and Dallas will make their request tomorrow. That occasionally happens.

Wow. I can't wait until the minutes to this meeting are released.