Fed Chairman Jerome Powell talked tough Wednesday, promising more rate hikes in the unrelenting battle against inflation, but he also let slip a few comments dovish enough to send the stock market sharply higher. The Federal Reserve raised interest rates Wednesday afternoon by a quarter point, as expected, and also kept a comment in its statement that it anticipates ongoing rate hikes. Stocks initially slumped and bond yields, which move opposite to bond prices, rose. SPX 1D line stocks Powell spoke afterward at a press conference, warning the market of more rate hikes and a tough stance on inflation. But traders seemed to cherry pick comments that had a dovish tilt to them, and the stock market reversed course and rallied hard. Bond yields fell. Powell said the Fed’s work was not done, but it was “gratifying to see disinflationary process underway, with continued strong labor market.” “The markets are off to the races. They read this as dovish. I think it was ‘gratifying’ and ‘disinflation’ were two words the market took to town,” said Diane Swonk, chief economist at KPMG. “The problem is, from the Fed’s perspective, they’re not done. He was sticking to his guns, but the market took ‘gratified’ and ‘disinflation’ and ran away with it.” Swonk said the markets latched on to those words even though Powell warned that the Fed is concerned that the deceleration in inflation could reverse. “It was hawkish humility because he’s clearly humbled by the deceleration of inflation but also not moving from his view and the Fed’s view that it will take time,” said Swonk. Powell also said he expects there’s a chance the Fed could achieve its 2% inflation target without a lot of economic deterioration. “I actually thought he did a pretty good job. It was kind of a hawkish thing at first,” said James Caron, head of macro strategies for global fixed income at Morgan Stanley Investment Management. Then “he just said we’re talking about a couple more hikes, and I think that’s what the market is keying on. A couple is generally two. That could be a hike in March and maybe one more in May.” The Fed’s rate hike Wednesday took the fed funds target rate range to 4.50% to 4.75%. The Fed has targeted a range of 5% to 5.25% as its terminal rate, or end point. Caron said the market seems satisfied with that level, and rallied when Powell’s “couple more hikes” comment suggested that’s where the Fed could stop. “To the markets, that’s like ‘so you’re telling us this it’!” Caron said. The S&P 500 popped above 4,100 in the Powell-fired rally. That’s a key level strategists were watching because it was the December high. At the same time, bond yields slipped, and the 10-year Treasury yield fell to 3.4% from a level just below 3.5% earlier in the day. .SPX 1Y line stocks Michael Schumacher, head of macro strategy at Wells Fargo, said Powell’s overall tone was dovish even though he was delivering a hawkish message. “The statement was fine. It had the desired reaction, and yet he came out of the press conference and threw out his comments about not wanting to overtighten,” he said. “People got all fired up when he said that.” Strategists had expected Powell to go out of his way to sound hawkish because the Fed does not want to create easier financial conditions. Stocks have been trading higher as investors continue to expect a soft landing, a decline in inflation and eventually a fed pivot to cut rates. One risk is that easier financial conditions as reflected in stock and credit rallies could lead to still more inflation. US10Y 3M line 10 year The futures market Wednesday afternoon began to price in a lower fed funds rate at the end of the year, meaning bigger odds of a rate cut. BMO rate strategist Ben Jeffery said fed funds futures were showing a terminal rate of 4.89% in the December contract, down from 4.92% Tuesday. “I think the bar for him to be hawkish was very, very high. The market was ready for anything he said, which could potentially be construed as dovish,” said Jeffery. “That’s all everyone was looking for and that’s what played out.” Jeffery said the Fed also could have indicated that it was no longer going to raise rates by larger amounts than a quarter point. In his statement, the Fed swapped out the word “pace” for “extent” of future rate hikes when describing what it would take into account in deciding on further increases. “To me they’re shifting from how fast to how high,” he said. He said that means the Fed focus is on how many more hikes rather than how large.