Ever since the economy started weakening in 2007 all the way until the Fed's first hike of this cycle in late 2014, the Fed's main concern has been boosting economic growth and improving employment. There has been mediocre success on the growth front, primarily a function of demographics, but luckily the fiscal policy stimulus through tax cuts and increased spending should spur growth in the short-term in 2018 and possibly 2019. The Fed started its hike cycle because it didn't want to have rates at zero as the cycle matured so it needs to raise rates in order to cut them in the next recession. The Fed is also worried about increased inflation at the end of this cycle. The Fed would rather start raising rates a few years before the inflation than need to play catch up. As a reminder, inflation is a decrease in purchasing power, which is not something you should strive for. The higher the real inflation, the greater the decline in purchasing power.

From 2014 until 2018 the Fed was hiking rates for those two reasons as there hasn't been much of a threat of inflation, as measured by the CPI and PCE in the intermediate term. However, that situation could change in the next year if the labor market slack is eliminated and commodities prices soar like they often do at the end of the cycle. We've seen oil rally this year, but the overall commodities index is still low. To put it in one sentence, the Fed's job will get much more interesting in the next year if inflation increases steadily and the yield curve flattens more. There could be a point where the Fed chooses between inverting the curve or allowing inflation to stay above its target. That would be the first time in years where the Fed is in a bind. The charts below show the flattening across various durations.

Source: The charts below

Inflation Soft In April

Even though inflation has been below the Fed's target for the first 4 months of 2018, there have been fears of elevated inflation earlier this year as investors like to extrapolate current data onto the future. If inflation continued at that pace for the rest of the year, it would be a problem, but it has decreased which has allowed stocks to rebound following the February turmoil.