After the Fed: Hesitation

Stocks can't capitalize on the FOMC's slightly dovish statement.
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Federal Open Market Committee

kept the fed funds rate unchanged at 5.25%, and delivered some kinder, gentler language on inflation Thursday. But investors only momentarily sighed with relief, and quickly returned to their previous worry-filled programming.

The stock market initially rallied on the FOMC news, but fell back to neutral amid the now familiar concerns about souring credit conditions stemming the tide of liquidity and leveraged buyout activity.


Dow Jones Industrial Average

and the

S&P 500

ended the day down a fraction at 13,422.28 and 1505.71, respectively. The

Nasdaq Composite

ended in the green, up 0.1% at 2508.37.

The FOMC edged another notch toward neutral by noting stronger economic growth and by removing the word "elevated" to describe inflation in its policy statement at the conclusion of Thursday's meeting.

Investors had been concerned the Fed may keep in the phrase as a nod to increasing inflation from energy and food prices. That would be a shift from the core inflation readings, excluding food and energy, that the Fed had trained the markets' eyes on.

The FOMC returned to similar language used in its January statement, saying: "Readings on core inflation have improved modestly in recent months."

But the Fed tempered the dovish tone, and nodded to higher overall inflation by adding that the inflation dragon is far from slain. "A sustained moderation in inflation pressures has yet to be convincingly demonstrated," the Fed said.

In other words, the central bank wants to see a series of low core inflation readings to be sure inflation will not succumb to whatever pressures may push it higher.

The Fed kept its slight bias toward tightening, noting that the "Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected." And on growth, the Fed gave a nod to the "ongoing adjustment in the housing sector," but added that regardless, the economy "seems likely to continue to expand at a moderate pace over coming quarters."

From the bond market's perspective, the statement wasn't quite dovish enough. The 10-year Treasury bond yield rose to 5.11%, up from 5.07% on Wednesday.

"They give you just enough information to be unclear," says Ethan Harris, chief economist at Lehman Brothers. "You can't in a few paragraphs explain everything you're thinking on an issue as complex as inflation."

Harris notes that the markets may be ready for the new communication strategy the Fed has been working on now for about one year. It is unclear when any changes to the current methods might be announced.

As far as the tea leaves can reveal, "the FOMC statement says they're happy with recent inflation readings, but they emphasize that they continue to be uncertain whether that will continue," says Harris. "It is about the forecast."

Harris and many other economists are concerned about the forecast for inflation to continue to moderate, given high energy prices and prices of other commodities.

Another clue that inflation may not behave itself was the revision to the quarterly core personal consumption expenditures for the first quarter to 2.4% from 2.2%.

"This does suggest that the current dip below the Fed's comfort zone in their preferred measure will likely prove transitory and that core inflation should remain quite stubborn in the period ahead, with real risk to the upside," writes Joe Brusuelas, chief economist at IDEAglobal.

Imbedded in the personal spending/income data, Friday brings the monthly reading of the core PCE, which analysts believe will rise 0.1%. The forecast is for its year-over-year rate to be at 1.9%, below the top end of the Fed's so-called comfort zone and down from a recent peak of 2.4% in February.

But "elevated" overall inflation may creep back into the FOMC statement if price pressures persist. The FOMC typically waits before highlighting high energy prices in the statement to ensure that the trend is not an anomaly, Harris notes. Indeed, investors should not necessarily gear up for rate cuts or a broader shift to neutral.

Last spring and summer, after energy prices spiked sharply, the FOMC statements included "elevated prices of energy and other commodities" as potential forces "sustaining" or "adding" to inflation pressures.

In the September 2006 statement, after energy prices had seen their peak, the Fed changed the language in its statements to note that "inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices." That language stayed there in the October and December meeting statements as well.

In January, the Fed removed all reference to energy prices, noting only the "high level of resource utilization," or the labor market, as having the potential to sustain inflation pressures.

But, from a stock market perspective in a week filled with concerns about the easy-money spigot turning shut, absence made the heart grow fonder.

The Fed's decision to refrain from a more hawkish bent because of high energy prices and to refrain from mentioning the problems in the credit markets was enough to prevent a selloff but not enough to spark a rally, says Art Hogan, chief market analyst at Jefferies & Co.

Among individual names, investors couldn't stop chattering about the launch Friday of


(AAPL) - Get Report

iPhone. Apple's shares fell 1.1% ahead of the launch.

After the closing bell, Apple iPhone competitor

Research In Motion


surged 14.3% on strong earnings after jumping 1.3% during the trading session. On the other hand, competitor,



slipped 4.3% in after-hours trading on a weak earnings report.

In a sign that the buyout craze is not over, investors cheered

General Motors'

(GM) - Get Report

news that it will sell its Allison Transmission unit for $5.6 billion to private-equity firms Carlyle Group and Onex Corp. GM's shares gained 2% on the news as


(F) - Get Report

added 2.3% on the day as well.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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