Naturally, the big news last week was not just the Fed’s widely anticipated 0.25% interest rate hike, but the statement made after the Federal Open Market Committee (FOMC) meeting last Wednesday. In summary, the FOMC statement said the Fed “expects economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate.” The big surprise was that the FOMC statement anticipated “gradual adjustments” in key interest rates as inflation materializes. Based on the Fed’s forecast that inflation will accelerate from this year’s 0.2% (in terms of the Fed’s favorite inflation index, the Personal Consumption Expenditure, or PCE index) to 1.6% in 2016, many Fed watchers assumed that the Fed would raise rates up to four times in 2016 (according to Bloomberg). However, the Fed’s past inflation forecasts are notoriously poor, so the Fed may not raise rates in 2016 if they are as “data dependent” as they claim.
What is fascinating to me is that the Fed refuses to acknowledge that there is deflation brewing. They are sticking to their mantra that inflation will soon materialize. At her press conference, Fed Chairman Janet Yellen said that the FOMC was “reasonably confident” that inflation would rise, despite flat prices now.
I was in Milan, Italy this past week, preselling my management company’s risk-adjusted portfolios, since foreign capital continues to pour into the U.S. As I had suspected, the view from Northern Italy was that the euro and the U.S. dollar will be at parity sooner than expected. Furthermore, the fact that our respective central banks are on divergent paths essentially insures that the U.S. dollar will remain strong; especially as long as Treasury yields remain well above equivalent European yields. Overall, Europe’s fascination with the Fed, a strong U.S. dollar, and falling crude oil prices dominated my conversations.
