Fed Sings Familiar Song

It raises fed funds to 3.5% and keeps the 'measured' vow.
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Updated from 3:14 p.m. EDT

The

Federal Reserve

carried out its 10th straight quarter-point interest rate hike Tuesday and repeated its long-standing vow to continue tightening the capital spigot at a "measured pace."

The policymaking Federal Open Market Committee raised the official fed funds rate to 3.50%, continuing a campaign of rate hikes that stretches back more than a year.

The FOMC made minor changes to its accompanying policy statement, adding an observation that "aggregate spending, despite high energy prices, appears to have strengthened since late winter," while repeating that "labor market conditions continue to improve gradually."

The FOMC also said Tuesday that "core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated." The wording represented a minor tweak to the June 10 statement, when the FOMC said that "energy prices have risen further" while "the expansion remains firm."

The second paragraph of the Fed's statement was identical to June's.

"The committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability," policymakers wrote.

Economists unanimously expected the quarter-point tightening after a series of strong economic readings that culminated Friday when the Labor Department said 207,000 jobs were added to U.S. payrolls in July. On Tuesday, the government reported better-than-expected worker productivity for the second quarter and a benign reading on wage inflation.

If anything, the July employment report fueled fears that the Fed may turn more aggressive in its year-long campaign to lift short-term interest rates, and there were "whispers" in the market that the Fed's language would reflect this.

"But there's nothing in there that indicates the Fed is going to get more aggressive," says Larry Berman, fixed-income strategist at CIBC World Markets.

That's also the assesment of Moody's economist John Lonski, who says that even though the Fed's assessment of the economy is more bullish, central bank governors still feel they can restrain inflationary pressures without resorting to more aggressive steps.

Relief was mostly seen in equities, where the

Dow Jones Industrial Average

closed at 10620, up 81 points on the day and up about 14 points in the period after the Fed announcement. The

S&P 500

rose 8 points at 1231 compared to 1230 before the announcement and the

Nasdaq Composite

was rose 10 points at 2174, unchanged from its pre-announcement level.

Bond prices, which had also risen after the productivity report, also moved up after the Fed statement. "We just had a bit of relief trade

after the productivity numbers because yields had risen all the way to 4.4%," says CIBC's Berman. "But we still expect yields to continue rising over the next several months."

The benchmark 10-year Treasury bond was recently up 8/32 and its yield down to 4.39%, compared with 4.41% ahead of the announcement.

The stock market, meanwhile, was in a position to take any excuse to move higher and run with it, after three straight sessions of declines, says Dan Hogan, head of Nasdaq trading at KeyBanc Capital. "This market is on a mission," he says.

"We've had oil trading towards $65 per barrel, the Fed just confirmed that rates are going up, and when you go by the textbook, that's not conducive to a move higher," Hogan says.