Reuters


Here's hoping America doesn't get the economy that the Federal Reserve is starting to envisage.
At first glance, the Fed's policy-setting committee on Wednesday delivered what investors expected: It cut its monthly bond purchases by a further $10 billion. It also scuttled a 6.5% unemployment rate as a threshold for when it will start thinking about raising rates.

 But changes in the details of Fed policy makers' forecasts disconcerted investors, as did a comment from Chairwoman Janet Yellen dropped during her news conference suggesting rate increases might come sooner than the market had thought.

 The Fed's new economic projections showed that on balance, policy makers expect gross domestic product to grow a bit more slowly over the next two years than they did in December, alongside a slightly lower unemployment rate, and a somewhat quicker pace of inflation.

 They also see short-term interest rates rising more quickly. The median forecast now calls for a fed funds target rate of 1% at the end of 2015, from 0.75% previously, and 2.25% at the end of 2016, from 1.75%. Ms. Yellen's comment that the first rate increase might come "six months" after the Fed ends its bond-buying program--on track to happen in December--reinforced the sense of a quicker move to tighten policy than many expected.

 The change in projections also suggests Fed officials have downgraded their view of the economy's efficiency. The shifts down in projections for both GDP growth and the unemployment rate imply an economy in which fewer of the people who have dropped out of the labor force return as things improve. That makes for an economy that generates more inflation at a lower rate of growth--a notion reinforced by the Fed's stepped-up expectation of when it will be time to raise rates.

 Investors didn't take all this too well, sending both stock and Treasury prices lower. But they may have reacted too quickly. Although the Fed's tone was more hawkish, that was predicated on a view of what the economy may look like in a year or so, not what it looks like now.
Today, there is clearly slack in the labor market, probably more than the 6.7% unemployment rate implies. The Fed's preferred measure for gauging inflation's underlying trend is up just 1.1% over the past year, falling well short of the central bank's 2% target.
That leaves plenty of time for the economy to prove the Fed wrong--and stay its hand.