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The Fed unexpectedly dropped the prospect of future interest rate hikes from its statement Wednesday, catching forecasters unprepared and sparking a stock and bond market rally. The Federal Reserve held its benchmark overnight lending rate steady at 5.25% for its sixth straight meeting, and said it is still concerned with inflation. But it dropped a reference to possible "firming" that may be needed to address inflationary risks, saying instead, "Further policy adjustments will depend on the evolution of the outlook." It also seemed to agree with indications that economic growth is slowing, saying, "Recent indicators have been mixed..." instead of January's "somewhat firmer." However, it referred to current core inflation readings as "somewhat elevated" vs. January's "improving modestly." Some investors hoped the Fed might mention the possibility of rate cuts down the road in light of recent mortgage-industry upheaval, but with long-term mortgage rates falling despite the TheFed 22 03 2007unchanged Fed rate, policymakers are apparently satisfied that ample credit is not a problem. Still, short-term interest-rate futures immediately shifted the odds of a 1/4 point rate-cut by midyear to 44% from 24% before the meeting. Economists were miffed by the removal of possible 'firming' from the statement; some saw it as a syntax change without significance, while others said Fed Chairman Bernanke "came to the rescue" of the markets from its subprime woes. After the statement, the DJ Industrial Average climbed 159.42 points to 12,447.52 -- its biggest one-day gain of the year -- leaving it down just 0.1% YTD. Treasuries rallied as well; the benchmark 10- vs. 2-year note yield entered positive territory for the first time since August, and closed flat.

Sources: Federal Reserve Press Release: January, March, Reuters, Wall Street Journal I, II, Washington Post
Commentary: Fed Statement, Revised For RealityFed Easing Cycles and Core CPI, 1960-PresentEconomists React [WSJ]
Stocks/ETFs to watch: S&P 500 Index (SPY), Diamonds Trust Series 1 ETF (DIA), iShares Lehman Aggregate Bond (AGG)
Related: Federal Reserve Monetary Policy, Interactive Yield Curve

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Source: Fed Holds Rates, Eases Stance