No, The Fed Isn’t as Dovish as the Market Thinks

Commonwealth’s McMillan notes that the central bank believes the economy is strong, so more tightening is coming.

So the higher-rate bogeyman is locked up in his box, eh? That seems to be what the stock market heard last week when the Federal Reserve stated that it would be “patient” with its schedule to raise short-term interest rates.

But that doesn’t mean that the Fed will back off its plans to tighten over the long-term, according to Brad McMillan’s read. “The market hears what it wants to hear, rather than what really is being said,” the chief information officer of Commonwealth Financial Network observed in a research note.

Part of the Fed’s statement was that it would “keep a larger pool of reserves on the balance sheet than historically without it meaning policy loosening,” McMillan wrote. This means that its primary focus going forward will be on interest rates.

The Fed, of course, has been embarking on a two-pronged approach to tightening: higher short rates and reducing the $4 trillion-plus mountain of bonds it bought to hold down long rates.

The market responded favorably last week to this news, with the S&P 500 climbing 1.6%. In all, stocks had their best January in 32 years, which was a relief coming off of late-2018’s gloom.

That gloom rested on fears that the economy, both in the US and globally, was going south, and that the Fed would heedlessly keep hiking rates. Thus the Fed’s statement came as a relief.

But McMillan pointed out that the Fed also indicated that it thought economic conditions were just fine. If the central bank thought otherwise, he wrote, “it would be saying that the economy is still broken and getting worse.”

He zeroes in on the Fed’s assessment that the “labor market has continued to strengthen” and “economic activity has been rising at a solid rate.”

In other words, more rate increases could be in our future.

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