Wait, What?

If you don’t have a sense of humor, the market’s reaction to the Fed minutes was probably pretty frustrating for you.

Initially, it looked like folks had determined that the committee wasn’t hawkish enough. Specifically, everyone seemed to be selectively keying on some of the more dovish language around the inflation outlook as equities initially spiked and the dollar took a dive. Here’s one excerpt that got some attention:

However, some participants saw an appreciable risk that inflation would continue to fall short of the Committee’s objective. These participants saw little solid evidence that the strength of economic activity and the labor market was showing through to significant wage or inflation pressures.

Of course there’s been some “solid evidence” of just that since the January meeting and indeed the entire selloff that rocked markets earlier this month was predicated on the idea that the average hourly earnings number that accompanied the jobs report “proved” (or at least “suggested”) that inflation pressures were building. That, in turn, presages a more hawkish Fed. Don’t forget the interplay here. Here’s DB’s Kocic:

What complicates things is that the behavior of real rates at this point is also a function of expected inflation: Higher inflation warrants a more hawkish Fed and therefore pricing in higher real rates. The reaction of stocks is a non-linear function of inflation – although risk assets might “like” higher inflation, this would remain true only up to a certain point.

And here’s the bank’s Dominic Konstam:

A Fed “behind the curve” maybe about a (bear) steepening in the nominal curve but if it is about a steepening in the real yield curve i.e. the promise of much higher real yields in the future, it is more ominous for equities all else being equal as opposed to a steeper inflation curve. The inflation curve matters not so much because of the threat of higher future inflation per se but because as and when the Fed no longer tolerates higher inflation at any stage, a more aggressive rise in real rates will likely reduce risk neutral rates, which is negative for equities.