Question:

Would the Bernanke Fed be more likely to tolerate

a.) inflation
b.) recession

We'll get to the answer in a bit, but first let's dissect what put the markets into a tizzy this afternoon, shall we?

January 31 FOMC statement;

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.

Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.

The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

March 21 FOMC statement;

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Recent indicators have been mixed and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters.

Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Okay, let's remove the language that is the same or similar and compare the two

 First paragraph.  Then;

Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market.  

Now;

Recent indicators have been mixed and the adjustment in the housing sector is ongoing.

The Fed removed the reference to firmer economic growth.  Thus, they believe the economy is slowing.  They also altered their perception of the housing market from "stabilization" to "ongoing adjustment," i.e. probably not stabilizing.  One could infer that the Fed believes the "adjusting" housing market is slowing the economy.  Score one for the easy money crowd.

Next paragraph.  Then;

Readings on core inflation have improved modestly in recent months, 

Now;

Recent readings on core inflation have been somewhat elevated.

The Fed believes that the risks of core inflation are higher now than six weeks ago.  A point to the inflation hawks.

Now, we have to break up the final paragraph into two parts.  The first part.  Then;

The Committee judges that some inflation risks remain.   

Now;

In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. 

At first, I thought this was a wash.  However, the Fed pointedly said that their most important issue is inflation.  So, we should give that to the inflation hawks.

Now, to the part that got the markets happy, happy, happy!  Then;

The extent and timing of any additional firming [emphasis added] that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Now;

Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Score one for the rate-cutters!  The Fed removed the one phrase in the entire statement that implies future action by the Fed, which was to increase rates, and replaced it with no action.  Thus, the market interpreted that as meaning the Fed is not only less likely to increase rates, but would lower rates!

So, back to our question at the beginning of the post.  Did you choose (a) or (b)? Would a Fed Chairman who has yet to establish his credentials as an inflation-fighter be willing to tolerate inflation or a recession?  Especially one who once said the Fed could drop dollar bills from helicopters in the sky to avoid deflation? 

The liquidity-junkies are saying today's statement preludes a cut.  Let's reiterate what the Fed said about inflation.

Recent readings on core inflation have been somewhat elevated. ...

the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected.

So inflation is still too high and the Fed's predominant policy concern is that it will stay too high.  This statement is less hawkish than the previous statement, but it is still hawkish!

And the market thinks that the next move is down?

We'll see.