Post FOMC

The Federal Reserve's rate decisions and statements are very important for the markets and cannot be underestimated. Their actions determine to a good extent the amount of liquidity that remains in the system and this will affect risk assets i.e. stocks.

The fed funds rate decision or statements about impending changes affect yields on US treasuries, which ultimately influences the decisions of central banks around the world because US treasuries are the mainstay of global central banks' reserves.

As expected, the FOMC kept its key rate at 0 - 0.25% for an 'extended period' in order to nurture the still fragile economy, citing that credit to households is still tight and that labor markets isn't yet in recovery. This 'extended period' phrase is key to the outlook of any rate hike - and it seems the FOMC has pointed out that it will look to inflation and the unemployment rate to improve before changing the phrase.

A change in the phrase to perhaps 'considerable period' (ala Greenspan some years ago) will have the most impact on USDJPY as the USD and JPY have the closest (and lowest) yields. It will surge on a fed funds rate hike.

Japan's inflation (or deflation) report out this week indicated that the government expects deflation until 2011, meaning the BoJ will likely not raise interest rates until then, so the yen will be the last in the developed world to enjoy a rate hike, putting the currency firmly as the ultimate funding (carry trade) currency for the foreseeable future.

Going back to the fed, even when they are focusing on both the inflation and unemployment rate for monetary guidance, I feel the bottleneck for a rate hike will be unemployment. Because it is hard to determine the peak and the fed historically wait a while longer after the peak before indicating a willingness to raise rates, there is likely to be a good time of waiting - which, to pro dollar investors, is really an 'extended period'. In another words, this fed looks to me to be a pretty dovish one for now, disregarding the change of incoming hawkish voting member(s) next year.

Friday's expected NFP figure is 175k job losses and a rise to 9.9% in the official unemployment figure. The government said unemployment rate is expected to peak above 10%.

Hence, for now, as long as stimulus is in place and extended by governments supporting risk sentiment, I feel the dollar will remain on the defensive and perhaps decline further against its major counterparts going into 2010.