Stocks sold off and bonds gained after the Federal Reserve disappointed markets with a less cautious statement than expected and a commitment to keep tightening.
The Fed raised interest rates by a quarter point, as expected, but lowered its median rate forecast to two hikes from three next year. The central bank also retained language in its statement that the market saw as more aggressive than expected, in terms of future rate hikes.
"There's a lot of nuance in the decision. I think what's pretty clear from the statement is Powell is not poised to turn sharply dovish," said Brian Dangerfield, macro strategist at NatWest Markets. "The Fed is going to be data dependent, but the data on which they are depending has not slowed dramatically."
Strategists had warned the market was braced for a very dovish Fed and stock traders had been hoping for a big bounce in the market after the Fed's move. But the Fed retained a comment in its statement that it would see "some" further gradual rate hikes, and changed it only by adding the word "some."
The Fed had been expected to raise interest rates by a quarter point, but signal fewer hikes in the future. It had also been expected to lower its growth forecast, and change the language in its statement to reflect it will be more dependent on incoming economic data. It did lower the growth forecast, and for 2019, it now sees growth at 2.3 percent instead of 2.5 percent.
Stocks sold off initially but then bumped around before heading lower again.
The market reacted negatively to a comment from Fed Chairman Jerome Powell that the central was pleased with the process it is using to shrink its balance sheet and expected to continue reducing debt purchases.
"I think the market reaction to all of this is the Fed is going to overdo it," said James Paulsen, chief market strategist at Leuthold Group.
"How else can you look at this than it just smells, at a minimum, like a really big slowdown in the economy coming, maybe even something worse," said Paulsen, based on bond market action.
"Powell said he sees no problem with balance sheet runoff. That's the one that hurts," said Paulsen. "That's another potential path of dovishness that he didn't take"
The Dow, meanwhile, is at its low of the year and bond yields fell. The 10-year yield fell to its lowest level since April.
"It just reinforces that between the Fed hiking and shrinking its balance sheet, it's double tightening in 2019. I think it just reinforced the market did not get the dovish hike it was looking for," said Peter Boockvar, chief investment strategist at Bleakley Advisory Group.
In the bond market, Treasury yields at the long end of the curve moved sharply lower, edging closer to the short end. So the 10-year and 2-year yield spread got closer together, in a so-called flattening move.
The two yields are very close and traders have been eyeing the spread in anticipation of an inversion, where the 2-year yield would rise above the 10-year — the sign of a coming recession.
"We have a bull flattening. Rates are falling and the curve is flattening. We have front yields which are basically unchanged. Long-end yields are coming down. That may speak to more concern," said Dangerfield. The flattening curve has been viewed as an economic warning.
The 10-year yield was 2.78 percent, down from about 2.83 percent, and the 2-year yield was at 2.66 percent.
Powell emphasized the Fed would not be on a preset hiking course. "From this point forward we are going to letting the data speak to us and inform us," said Powell, adding that that would make the path of tightening uncertain.
Powell's message was moderated and stocks came off the lows of the day when he said the Fed was at the bottom end of the range for estimates for the neutral rate. Neutral is the level that is neither stimulative nor slowing for the economy, and there is much debate about where that level is. Powell also gave a nod to weaker financial conditions and said they played a role in the change in forecasts and interest rate expectations.
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