Few things matter more to Wall Street than

Federal Reserve

policy, which ultimately determines the cost of capital and, by extension, how much risk investors are willing to take. In the wake of the robust March employment report on April 1, you'll recall, many market participants began to quickly

unwind aggressive bets in various markets.

Fed fund futures are still pricing in over 90% odds of a 25-basis-point rate hike at the Fed's next scheduled policy meeting on June 30. But concerns about a more aggressive Fed have declined significantly in the face of some middling economic data, including this week's new-home sales, durable goods and consumer confidence data, as well as last week's weaker-than-expected reports on housing starts, index of leading economic indicators and the Philadelphia Fed Index.

"The recovery is now quite resilient to shocks, and a new recession is therefore quite unlikely this year," Anirvan Banerji, director of research at the Economic Cycle Research Institute and

RealMoney.com

contributor, said in an email exchange. "Still, growth is likely to decelerate, after accelerating since the end of the Iraq war." (As reported

here, ECRI believes the current above-trend growth of 4.5% to 5% is likely to start moderating back toward the economy's long-term trend of 3% to 3.5% growth.)

Granted, first-quarter GDP was revised up on Thursday to 4.4% from 4.2% originally. But the personal consumer expenditures index, or PCE -- purportedly one of Alan Greenspan's favorite inflation measures -- was revised down to 3% from 3.2%, and the core PCE was revised down to 1.7% from 2%.

"The market had assumed a much faster pace of tightening than what's occurring now" in terms of expectations, said Liz Ann Sonders, chief investment strategist at Charles Schwab. "

Thursday's news in particular with the revision down to PCE inflation

and some hope oil prices might wane a bit" -- crude futures fell 0.7% to $39.16 Thursday -- "are the behind action in stocks and bonds," among other financial indicators suggesting an unwinding of tightening fears that only recently consumed Wall Street.

Stock proxies have been rebounding from their mid-May lows, with the Dow Jones Industrial Average rising 0.9% Thursday while the S&P 500 gained 0.6% and the Nasdaq Composite climbed 0.4%.

Since peaking at 4.86% on May 13, yields on the 10-year Treasury have fallen 26 basis points. On Thursday, the price of the benchmark note rose 14/32, its yield falling to 4.60%.

After jumping $6.70 to $396.10 per ounce Thursday, gold futures have now risen 6.7% since hitting a seven-month low of $371.30 on May 10.

The dollar, which had rallied on expectations the Fed would narrow the differential between the fed funds rate and other global lending rates, has weakened recently and slumped Thursday, hitting multi-month lows vs. the euro, yen, Swiss franc and British pound.

"With most of the rising rates scenario already priced into the market, falling yields have allowed stocks, bonds, gold and foreign currencies to rally over the past two weeks as liquidity has returned to the market," commented Jes Black, currency analyst at MG Financial Group. "It appears that the reflation trade of 2003, which began to unravel in March, might see a multiweek comeback."

To update what I wrote

Wednesday: If consensus comes around to a more benign view of the Fed, Thursday's rally will very likely continue, and almost certainly, many traders will grasp for more aggressive/speculative names.

Notably, the recent equity market advance has been paced by higher beta (or more speculative names), including Chinese Internet stocks such as

Sina

(SINA) - Get Report

and domestic security plays such as

Magal Security Systems

(MAGS) - Get Report

. There has also been renewed interest in previously suffering tech and telecom heavyweights such as

Siebel Systems

( SEBL),

Nortel

( NT),

Sun Microsystems

(SUNW) - Get Report

and

Tech Data

(TECD) - Get Report

.

Caveats Abound

Of course, recent market action might merely be a reversal from the market's arguable overreaction to prospects of Fed tightening, exacerbated by the quasi-holiday atmosphere this week. Notably, Fed Governor Ben Bernanke said last week: "The good news is that, because of the impact of private-sector expectations about policy on long-term rates, a significant portion of the financial adjustment associated with the tightening cycle may already be behind us."

More crucially, however, Bernanke also said "the flareup in inflation in the first quarter is a matter for concern," and the

Fed's pledge to adjust policy in a "measured" fashion was "not an unconditional commitment."

Meanwhile, inflation pressures are in a cyclical upturn, according to Banerji.

The so-called break-even rate for Treasury Inflation Protected Securities (also known as TIPS) suggests -- for the first time since their introduction -- that "the market believes that inflation will be higher over the next 10 years than it was over the last 10," according to Bianco Research in Chicago. "In other words, the market believes that a secular change in the direction of inflation, from down to up, is taking place."

Notably, personal income was revised up in both the first- and fourth-quarter GDP reports; faster wage gains would remove one of the Fed's most powerful arguments for "measured" tightening.

In sum, it's premature to declare the tightening scare to be over, or even overdone. But until next Friday's employment report for May -- which will likely cement expectations, either way, for the June 30 Fed meeting -- the financial markets' upward trajectory is likely to continue amid diminishing fear of the Fed.