The US Federal Reserve may just have pulled the exuberance of global financial markets down a notch in its monetary policy statement on June 16. The Dow Jones Industrial Average (DJIA) shed a hefty 3% of its value between June 16 and 18. The rupee moved a good 80 paise down against the dollar and analysts point to more depreciation. (There has been a subsequent pullback in the markets. But whether this is merely a ‘correction’ or a resumption of the financial markets’ northward march remains to be seen.)What spooked the markets? The powerful Federal Open Market Committee (FOMC) that decides things like interest rate levels and the amount of cash that the Fed prints did not do anything dramatic. The policy interest rate was kept at zero, and the massive cash infusion programme ($120 billion a month) was left untrimmed. The financial markets took their cues, instead, from the change in the projections that the 18 members of the committee pencilled in.Growth Good, at This Rate Thirteen of them favoured at least one policy rate increase by the end of 2023, versus only seven in the March 2021 policy meeting. Eleven member officials predicted at least two rate hikes (25 basis points each) by end-2023. Interestingly, seven members actually saw a rate increase as early as 2022, up from four members in March. The Fed also raised its inflation and growth forecasts for 2021 and the next two years.The upward revision was the largest for this year, at a full percentage point for inflation and half for growth. Fed Chairman Jerome Powell also indicated that discussions on tapering the aggressive bond purchase programme — the Fed buys bonds from financial institutions to infuse money —would commence soon.A little background may help to make sense of this gobbledygook. Over the last nine months, financial markets, stocks in particular, have resolutely uncoupled from the economic fundamentals on the ground, despite havoc wrought by the Covid pandemic.As Covid cases began to ratchet up in the US from October 2020, so did the DJIA index. Other markets told a similar story. The Sensex gained by over 50% over the last 12 months, never mind the fact that GDP contracted over the period, or that two major Covid waves battered the economy. The only way to rationally explain this disconnect is to argue that investors were firmly focused on future economic performance, as vaccines promised an end to the pandemic and massive fiscal and monetary stimuli contained immediate economic damage. Sceptics argue that this irrational exuberance was just a case of cheap liquidity seeping into any asset market that offered the faintest possibility of a decent return.The US and European central banks alone pumped in around $7.5 trillion since March 2020. As more and more investors got on the bandwagon, prices spiralled up. These sceptics have long argued that at the first sign that the major central banks were readying to take the punchbowl away, financial markets would cool off and, perhaps, reverse course. That seems to be precisely what happened on June 16.But why scare the markets in these difficult times? Why not keep the money engines chugging instead? The problem is inflation — driven partly by sharply rising commodity prices (the Commodity Research Bureau index rose by 24% since January), labour shortages in sectors like hospitality that have reopened after a long lockdown and rising consumer demand on the back of hefty fiscal stimulus. US consumer price inflation rose 5% in May, its highest increase in the last 13 years.Reading Tea LeavesTextbooks claim that high inflation is invariably the result of too much money chasing too few goods, and central banks need to apply the brakes on monetary stimulus. The Fed’s (and other central banks’) party line has been that this elevated inflation is the result of supply-side frictions caused by disruptions caused by the pandemic, and are likely to be transient. However, June 16 forecasts seem to suggest that a fair number of the FOMC members believe that inflation is here to stay, and a degree of rectitude is warranted.Financial markets are known to be fickle, and prone to interpreting the same policy communiqué differently at different times. Thus, it is possible that soon enough they will read the June 16 policy as an affirmation that the US economy is picking up faster than expected and rally again.Besides, China, a big commodity guzzler, is making a serious bid to rein in commodity inflation by releasing its own reserves in the open market. It might just have the heft to do this. It is sitting on 2 million tonnes of copper reserves, 800,000 tonnes of aluminium and 350,000 tonnes of zinc. This could unveil the proverbial ‘Goldilocks’ scenario — neither too hot nor too cold — of rising growth and low inflation.Multiple views and scenarios make for increased volatility. Thus, financial markets could see its fair share of both ups and downs, depending on which set of investor belief dominates. If I were a betting man, I would put my money on the Fed following through on its warning and slowly switching to neutral gear. If this is well calibrated and communicated carefully by the Fed and other central banks, markets may not crash. However, the days of runaway increases in asset prices might be over.