Last week the U.S. Federal Reserve moved one step closer to acknowledging reality.

Unfortunately, it didn’t let that admission move it from a policy course firmly guided by fantasy - meaning the central bank opted to stand pat on interest rates, despite the clear escalation of inflationary pressures.

In the policy statement that accompanied that decision last week, Fed Chairman Ben S. Bernanke and the other members of the interest-rate-setting Federal Open Market Committee (FOMC) took an important step in noting that inflationary concerns had taken hold in the country at large.

But as it asserted that it expects inflation to moderate this year and next, the Fed gave no indication that these heightened expectations are gaining traction within the FOMC itself. As a result - with Richard Fisher, president of the Federal Reserve Bank of Dallas, casting the sole dissenting vote - the FOMC signaled no likelihood that it was actually prepared to do something to fight a problem that it doesn’t really seem to believe exists in the first place.

In fact, by indicating that it expects inflation to moderate, the Fed is effectively saying that the elevated expectations are unwarranted. In other words, Bernanke claims that despite the fact that so many people are carrying umbrellas, he still believes it will be a sunny day. The takeaway from the statement is that no rate hike is forthcoming.

The markets saw this position for what it really is - a capitulation to inflation and to a weakening dollar.