Crude oil prices and inflation
For now, policymakers are of the opinion that the low crude oil prices, which have pummeled ETFs like the United States Oil Fund, LP (USO) and the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) will trouble inflation only in 2015 and not beyond that. However, if crude prices drop further, and inflation takes a beating because of that, it may force the Fed to wait longer on pulling the interest rate trigger.
Market participants, which expect the Fed to hike the interest rate around mid-2015, will be devastated. Volatility can result, fueling ETNs and ETFs like the iPath S&P 500 VIX Short Term Futures ETN (VXX) and the ProShares VIX Short-Term Futures ETF (VIXY).
A dovish Fed
The Federal Open Market Committee (or FOMC) comprises of 12 members. Seven of these are the Board of Governors of the Federal Reserve System and one is the president of the Federal Reserve Bank of New York. The remaining four positions are filled by 11 Reserve Bank presidents, who each serve a one-year term.
According to this rotation policy, four members will leave the FOMC this year and thus lose their vote in the policy. Richard W. Fisher (Dallas Fed), Narayana Kocherlakota (Minneapolis Fed), Loretta J. Mester (Cleveland Fed), and Charles I. Plosser (Philadelphia Fed) will move out of the committee. Except for Kocherlakota, the other three are generally considered hawkish, which means that they are more aggressive towards their stance of raising the interest rate.
Charles L. Evans (Chicago Fed), Jeffrey M. Lacker (Richmond Fed), Dennis P. Lockhart (Atlanta Fed), and John C. Williams (San Francisco Fed) will fill these positions. Except Lacker, the remaining three are considered to be doves. Thus, if inflation fails to pick up, they are more likely to play safe and not raise the interest rate. This will impact Treasuries (SHY) (TLT).
Apart from the federal funds rate, normalizing its balance sheet is also something that the Fed intends to do. In the next article, we’ll see what the Fed had to say about this aspect.