As universally expected, the Fed kept its main policy rate unchanged at 5.25% yesterday. However, it watered down its "bias" to tighten policy further. Over the past few months, the FOMC had been talking about "the extent and timing of any additional firming that may be needed" when describing the outlook for policy. In the Fed's view, rates were more likely to go up, in order to contain inflation risks, than to go down. Yesterday, the FOMC continued to express its concern about inflation, but it dropped the reference to "any additional firming." In essence, the Fed is giving itself wiggle room to cut rates should the need arise.

The stock market rallied strongly yesterday afternoon in the wake of the news, and the short-end of the U.S. yield curve shifted down 5 to 8 basis points. In addition, the dollar weakened across the board with the dollars/euro exchange rate briefly touching a 2-year high yesterday afternoon. Data released this morning in the United Kingdom showed that the volume of retail sales jumped 1.4% in February relative to the previous month. The robust outturn, in conjunction with the higher-than-expected CPI inflation data the other day, raises the likelihood that the Bank of England will tighten policy again. Sterling has risen to a six week high versus the greenback this morning.

The docket this morning includes the weekly series on initial jobless claims. A significant increase in claims would raise concerns that the labor market is starting to weaken, which would likely lead to further dollar weakness. On the other hand, the greenback could get a respite if claims posted a decline last week. That said, we project that the dollar will continue to trend lower in the quarters ahead. (For details, see our most recent "Monthly Economic Outlook", which is posted at www.wachovia.com/economics.)