How the Fed Finally Cracked Wall Street's Shell of Disbelief

Wall Street had looked forward to Wednesday as a major news day for weeks, but when the moment came, investors didn't like what they saw. Although losses for the Dow Jones Industrial Average (^DJI 0.40%) were minimal, larger drops for the Nasdaq Composite (^IXIC 2.02%) and S&P 500 (^GSPC 1.02%) showed general disdain for the latest pronouncement from the Federal Reserve.

Data source: Yahoo! Finance.

The Federal Open Market Committee concluded its two-day meeting on monetary policy Wednesday afternoon, and all of the market's declines came after the 2 p.m. ET release. Even though the Fed didn't take immediate steps to tighten its monetary policy stance, it still suggested that more rate hikes could come before the year is out. That's not inconsistent with the message the Fed has sent all year, but it appears that the investing community is finally starting to believe its words .

What the Fed said

There wasn't a whole lot of new information in the Federal Reserve's release Wednesday afternoon. The central bank still sees the economy expanding at a solid pace, with a strong job market and low unemployment. Yet inflation remains at elevated levels, and despite tighter conditions in the credit markets for both consumers and commercial borrowers that will likely weigh on the strength of the economy, central bankers are still laser-focused on not letting inflation get entrenched in economic expectations.

The Fed chose not to make any changes to interest rates at its September meeting, leaving its target for the federal funds rate at a range of 5.25% to 5.5%. However, policymakers reaffirmed their strong commitment to get inflation back to its 2% target, and it left open the possibility of taking further action to adjust monetary policy in response to a wide variety of information sources. Should inflationary pressures flare up again, for instance, it appears likely from the Fed's statement that it would be prepared to raise interest rates further.

The Federal Reserve. Image source: Getty Images.

Watching the "dot plot"

Some of the more interesting information from the Fed came not from the words of Chair Jerome Powell but rather from the supporting information included in the release. In particular, many market participants have taken to looking at the assessment of various Federal Open Market Committee participants about what monetary policy will be appropriate both now and in the years to come. This so-called "dot plot " shows the number of participants believing that the federal funds rate will be within certain ranges.

In the short run, the Fed seems committed to keeping rates high. The majority of participants see one more quarter-point rate hike by the end of 2023. Views are more spread out with respect to what will happen in 2024, with a range of year-end projections from 4.25% to 6%. In the long run, most Fed officials believe the fed funds rate will return to around 2.5%, but it could take several years for central bankers to feel comfortable enough about inflationary conditions to loosen their monetary policy stance to that extent.

Bond market investors seemed surprised by the pronouncements, with rates moving higher across the yield curve. The bias against high-growth stocks was clear, as higher rates raise the extent to which future earnings get discounted in some stock-valuation models.

Yet all along, the Fed has said that it would maintain a tight stance on monetary policy until inflation was completely under control. Despite a few favorable signs, the Fed hasn't beaten inflation just yet, and that makes higher rates for longer a virtual certainty.