Contemplating the Fed's Encore

Wednesday's sharp selloff in Treasuries reflected rising expectations that the Fed will now stand pat for the foreseeable future. Prior to the meeting, expectations were that the central bank would either cut by 50 basis points Wednesday or by 25 basis points and another 25 basis points in August. "Now, you must calibrate for a 1% fund rate through summertime, perhaps into fall," he said. "That's one reason the bond market [sold] off."

As detailed here, Sullivan is skeptical that the signs of economic improvement cited by the Fed will prove sustainable. But "I have to be flexible [and] respect the Fed's sense that evidence pointing to improvement will ultimately be reflected in government statistics," he said. "There is a lot of stimulus in place -- fiscal and monetary -- and in the past the economy has responded to huge infusions of liquidity."

Clearly, many equity market participants are betting that the combination of tax cuts and aggressive monetary policy will be sufficient to propel the economy into a more robust recovery. Stock traders didn't seem overly concerned Wednesday by the Fed's decision, and many suggested that 25 or 50 basis points wouldn't have made much difference. Following the afternoon selloff, many traders reassured themselves that quarter-end window dressing will provide the market a short-term boost, regardless of what the Fed did or didn't do Wednesday.

Who's Got Next?

In some regard, the relevant question for financial markets is when the Fed next contemplates raising rates, and "they didn't give any indication that's in the foreseeable future," observed Paul Kasriel, chief U.S. economist at Northern Trust in Chicago.

Indeed, the Fed repeated a warning that "the probability, though minor, of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level." In a new twist, the Fed said that relationship "is likely to predominate for the foreseeable future."