Updated: 06-23-2017

The latest Federal Open Market Committee (FOMC) meeting is going to give market participants plenty to think about and to talk about -- and perhaps not in that order.

Today's policy announcement, which was replete with a rate hike, a dissenting vote, updated economic and rate-hike projections, and a specific plan for how the Fed will start to normalize its balance sheet, needs to marinate some more before it truly sinks in.

In terms of the interest rate decision, the FOMC did what was expected: it raised the target range for the fed funds rate to 1.00% to 1.25%. Minneapolis Fed President Neel Kashkari cast the only dissenting vote, saying he preferred to maintain the existing target range for the fed funds rate.

The decision to raise the target range was attributed to realized and expected labor market conditions. In other words, it sounds as if the Fed is still expecting tight labor market conditions to produce stronger wage inflation that will presumably drive broader price inflation.

The confounding element in that assumption is that the central tendency PCE inflation projection for 2017 was lowered from 1.8% to 2.0% to 1.6% to 1.7%. In addition, the 2018 PCE projection was narrowed from 1.9% to 2.0% to 1.8% to 2.0% while 2019 was left unchanged at 2.0% to 2.1%. Most Fed members (12 out of 16), nonetheless, are still projecting another rate hike this year and three more rate hikes in 2018.

That understanding may very well stir concerns in the market that the Fed is running an increased risk of making a policy mistake by raising rates too much, too soon. That view had already started to manifest itself in the narrowing spread between the 2-year note and the 10-year note, which currently stands at 81 basis points versus 130 basis points when the FOMC raised the target range for the fed funds rate to 0.50% to 0.75% on December 14, 2016.

In short, the FOMC has raised rates two more times since December, and yet the yield curve has flattened considerably with the inflation-sensitive back end of the curve leading the flattening move.

That action is seemingly out of sync with a strengthening growth outlook that seems to be forming the FOMC's policy expectations.

The Fed, however, is sticking to its hopeful outlook and it sounded an important note in that respect by releasing a specific plan to reduce its holdings of Treasury and agency securities. Those details can be found by clicking on the embedded link.

The Fed said it expects to start implementing a balance sheet normalization this year, but issued the caveat that it will do so only if the economy evolves broadly as anticipated. Fed Chair Yellen in her press conference further reminded market participants that policy is not on a preset course, which means it isn't a guarantee the balance sheet normalization will begin this year.

The salient takeaway today, however, is that the Fed stands ready to begin the process, so in that regard in can be thought of as a somewhat hawkish development given that the intention of the plan is to remove policy accommodation.

It's part of the Fed's communication policy, which is oriented around telegraphing changes in the path of monetary policy so that negative surprises, and volatility, are minimized in the capital markets. That has been a supportive approach thus far, certainly for the stock market.

If the Fed's tightening policy evolves more quickly than the markets think is appropriate, though, the Fed's thinking could soon fall on deaf ears and usher in the volatility it has been aiming to suppress and at the same time suppress an economic recovery it has been aiming to bolster.

--Patrick J. O'Hare, Briefing.com

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