The Federal Reserve Open Market Committee (FOMC) issued its statement almost exactly as expected. The language on interest rates is remaining low for an extended period of time remained largely unchanged, and the decision was unanimous.

As I have mentioned earlier, the Fed continues to avoid any potential language which could disrupt the financial markets. Any potentially controversial ideas seem to be reserved for speeches by the Chairman and other government officials.

Investors received yet another indicator Monday that this is not your father's recession.

The global economy will likely contract in 2009 for the first time since World War II -- including a decline in trade - - the World Bank announced in its most recent report.

The dollar fell, then firmed, against most of the world's other major currencies Tuesday at mid-day, on word of yet another U.S. government intervention to ease the financial crisis. (For full currency data, click here.)

Still, the more important theme, many economists and analysts agree, is how well the dollar has fared given the remarkable increase in debt by the United States and the supply of dollars globally.

The dollar weakened about one cent to $1.3040 versus the euro and about half a cent to $1.5160 versus the British pound on Tuesday at mid-day, after the U.S. Federal Reserve announced it would buy up to $600 billion in mortgage and mortgage servicer-related debt and up to $200 billion in consumer and small business-backed loans, to free up credit in these sectors. The dollar also fell about one cent to 95.53 versus Japan's yen, and about half a cent to $1.1881 versus the Swiss franc.

Under the new programs announced Tuesday, the U.S. Treasury will provide about $20 billion in credit protection to the U.S. Federal Reserve, using money from the $700 billion Troubled Asset Recovery Program (TARP).

In September, the Fed's balance sheet totaled $924 billion, when the first wave of the financial crisis began to freeze credit markets and decimate stock markets around the world. However, if all loan guarantees are accessed, and if all of the remaining $780 billion debt is added to the Fed's balance sheet, that balance sheet would increase to about $3 trillion.

Based on October wholesale and consumer price reports, July 2008 marked a shift from inflation into full-blown deflation. This has much to do with the declining price of oil, which in turn is related to the collapse of speculative buying of oil while shorting the dollar; the decline in demand resulting from a global downturn; and the failure of producers to cut supply fast enough.

However, as I posted, there's a vicious cycle underway which leads to:

1. Excess inventory,
2. Price cuts,
3. Capacity and job reductions,
4. Less spending power,
5. Lower demand -- followed by a return to step 1.

And with jobless claims at 542,000 and the price of oil down below $50, it's pretty clear that this cycle is well underway. What can the Federal Reserve do to turn this vicious cycle into a virtuous one? It is likely to cut the Fed Funds rate to zero or very close to it -- 0.25% -- in January. But in a 2002 speech, Bernanke said that there are other ways the Fed could try to boost overall demand, which would reverse the deflationary cycle.

The thaw in short-term interest rates continues.

The effort by major central banks to increase the supply of dollars globally to free-up credit continued to move rates in the right direction Wednesday -- down -- as private banks were encouraged by commercial paper purchases by the U.S. Federal Reserve and a likely interest rate cut later today.

The London rate for three-month loans in dollars declined for the 13th consecutive day, dropping 5 basis points to 3.42%. The three-month rate for the euro, the Euribor, also fell 2 basis points to 4.83%, and the three-month rate for Hong Kong dollars, the Hibor, dropped 30 basis points to 3.54%.

Short-term rates, including overnight rates, are key sources of cash for corporations and other large institutions, which use the cash to pay suppliers, make payroll, roll over debt etc. Hence, very high overnight and short-term rates will discourage corporations from conducting business, restricting commerce and slowing the economy, economists say.

In comments made June 23 to Germany's Die Zeit but published only today, European Central President Jean-Claude Trichet warned of an "explosion" in inflation if the bank does not act decisively to counter it, Reuters reported Wednesday.

"If we are not resolute, there is a risk that inflation will explode. If we act decisively, then we can master the situation," Trichet said in the German text of comments published by weekly Die Zeit on Wednesday.

Trichet's comments appear one day before the ECB's meeting on interest rates. Many economists expect the ECB to increase its key interest rate, the refinance rate, by 25 basis points to 4.25%. (The ECB decision will be announced Thursday at 7:45 a.m. EDT.)

At issue: How to check inflation

European inflation is running at a 3.7% annualized rate, and trending up. That fact, combined with Trichet's comments published Wednesday, "all but guarantee a rate hike Thursday by the ECB," in economist David H. Wang's interpretation.

So much for consensus building.

That was how one currency trader characterized the present mood in the currency markets regarding the European Central Bank's upcoming Thursday July 3 meeting to discuss interest rates and monetary policy.

"Initially there was talk that [ECB President Jean-Claude] Trichet would make a concession to the doves, and hold off raising rates for this meeting, but now the belief pretty much is that they'll raise rates a quarter point to 4.25%," currency trader Andrew Resnick said Monday. Resnick added that he is short with the dollar in the euro-dollar and British pound-dollar currency pairings.

European inflation is running at a 3.7% annualized rate, and trending up, Resnick said, and "a 4% refinance rate just doesn't look like it can cut the mustard and contain inflation the way Trichet wants inflation contained." If the ECB increases the refinance rate -- its key, short-term interest rate -- it would be the bank's first increase in a year.

The U.S. Federal Reserve announced Tuesday an expansion of its securities lending program.

The actions announced today supplement the measures announced by the Federal Reserve on Friday to boost the size of the Term Auction Facility to $100 billion and to undertake a series of term repurchase transactions that will cumulate to $100 billion.

The Fed added that "since the coordinated actions taken in December 2007, the G-10 central banks have continued to work together closely and to consult regularly on liquidity pressures in funding markets. Pressures in some of these markets have recently increased again." The Fed added that central banks "will all continue to work together and will take appropriate steps to address those liquidity pressures."

"To that end," the Fed said, "today the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are also announcing specific measures."

Fed Analysis: Without question, the Fed is attempting to head-off any building, short-term liquidity crunch banks may face in the weeks and months ahead. This latest increase in the Term Auction Facility, the coordination with the other major central banks indicates monetary, and lengthening of the primary dealers' term to 28 days from overnight will help the Fed and the other central banks achieve that liquidity goal.

The U.S. Federal Reserve said that despite inflation concerns, "relatively low" interest rates may be needed "for some time," the central bank announced Wednesday in the minutes from its most-recent meeting. At the same time, however, the Fed raised its inflation projections for 2008.

"Several participants noted that the risks of a downturn in the economy were significant,'' the Fed said in minutes of the January 9 and 21 conference calls and the January 29-30 policy meeting last month. "Many participants were concerned that the drop in equity prices, coupled with the ongoing decline in house prices, implied reductions in household wealth that would likely damp consumer spending.''

Last week, in Congressional testimony U.S. Federal Reserve Chairman Ben Bernanke indicated that the Fed will lower rates further if financial conditions and the availability of credit deteriorate.

Also in the minutes, the Fed termed the inflation statistics since the end of the year, "disappointing." The Fed now expects 2008 core inflation of 2.0-2.2%, up from the previous 1.7-1.9% estimate.

Further, the Fed lowered its 2008 U.S. GDP outlook to 1.3-2.0% from the earlier 1.8-2.5%.

The selling in Europe continued before the markets staged a mild rebound -- which analysts attributed to short-covering and/or the U.S. Federal Reserve's action Tuesday morning to slash both the Federal Funds rate by 75 basis points to 3.50% and the Discount Rate by 75 basis points to 4.00%.

"The Fed's intervention...true, won't necessarily stop the selling that people are doing for fundamental reasons, but it will help calm the markets and reduce people's urge to sell because they fear the markets will freeze up....sell for fear reasons," London-based economist Mark Chandler told BloggingStocks on Tuesday.

There was also talk that the Fed's action will be coordinated with or followed by ensuing actions by the European Central Bank and the Bank of England to ensure the proper function of the markets, Chandler said.

At mid-day Tuesday, Europe's major bourses were down an average of 1% across the board. London's FTSE was down 24.90 points to 5,553.30, France's CAC 40 fell 56.86 points to 4,687.59, and the German DAX fell 147.32 to 6,642.87.

In response to the global equities sell-off and the likely pressure on U.S. stock markets when they open later today, the U.S. Federal Reserve slashed the Fed Funds rate by 75 basis points to 3.5% Tuesday morning.

The Board of Governors also approved a 75-basis-point decrease in the discount rate to 4%. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Chicago and Minneapolis.

The Fed said:

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

While the release said that "Appreciable downside risks to growth remain," it also mentioned that the committee expects "inflation to moderate in coming quarters." No doubt, the Fed has made its choice for now, preferring to stimulate the economy despite risking higher inflation. With lower oil prices -- caused by fears of lower demand as the economy slows down -- the Fed may have less to worry about inflation.

Has this move been enough? So far, futures indicate it may have been -- at least for today -- as their losses aren't as steep as before the announcement. Even with this Fed cushion, I'd expect the session to be bumpy.

When Ben Bernanke testifies before the House Budget Committee today, he's expected to announce his support for a short-term economic stimulus package, as long as it's based on measures that are quick and temporary, according to the New York Times this morning. He's told lawmakers he won't comment on proposals to link a stimulus package to the permanent extension of President Bush's tax cuts.

Finally some political sanity. I wish Alan Greenspan had taken that stance as President Bush continued to cut taxes during a war. If Greenspan had we wouldn't have added so much to U.S. debt and this country would be in much better shape fiscally to get us through the current credit storm.

Bernanke's support for the short-term fix is critical to getting many lawmakers to accept a stimulus package even if it means adding to the U.S. deficit. Without it, Congress probably could not pass a veto-proof economic stimulus package. President Bush would likely veto anything that doesn't include a permanent extension of his tax cuts to try to bully the Congress into continuing his economic folly - paying for a war on future debt. Our children certainly will hate us for a long time if we continue to ignore the burden we're putting on them.

The dollar plunged to a two-year low versus Japan's yen Tuesday, and retreated against other major currencies, on fears the U.S. economy has fallen into a recession, Bloomberg News reported.

The dollar fell 1.26 yen to 106.90 versus the yen. Meanwhile, the British pound rose about 1.5 cents to $1.9704 in mid-day Tuesday trading. The dollar was virtually unchanged versus the euro at $1.4862.

Economists and analysts say a recession in the United States would invariably drive the dollar lower, due to foreign investors' reduced demand for dollar-denominated U.S assets, many of which would underperform during a recession. The dollar also would be hurt by lower interest rates, a near-certainty in the months ahead, with the U.S. Federal Reserve widely expected to again cut benchmark, short-term interest rates to jump start the U.S. economy.

On Wall Street, there are forecasts...and then there are forecasts that investors/readers ignore only at their peril.

Put investment banking giant Goldman Sachs decidedly in the later category.

On Wednesday, Goldman Sachs (NYSE: GS) said the U.S economy is probably slipping into a recession, and also predicted that the U.S. Federal Reserve will cut its benchmark interest rate, the Fed funds rate, substantially, to 2.5% from 4.25% by third quarter, Bloomberg News reported.

Goldman, which projects an anemic 0.8% growth rate for the U.S. economy for all of 2008, also said it expects the Fed to lower its key interest rate to 3% by the middle of 2008, Bloomberg News reported.

To counteract the effects of the housing's sector's correction and other drags on the U.S. economy, including high energy prices, the Fed has cut benchmark interest rates three times since September.. The Fed Funds rate, the rate banks charge each other, now stands at 4.25%, and the discount rate, the rate the Fed charges banks for short-term loans, is at 4.50%. The Fed also set up a special term auction facility to help banks maintain short-term liquidity.

Federal Reserve Bank of Philadelphia President Charles Plosser indicated that further interest rate reductions may be needed to stimulate the U.S. economy, should economic growth become "substantially weaker" than already projected, Bloomberg News reported Tuesday.

"A substantially weaker outlook than expected, particularly if that weakness is projected to be more prolonged than anticipated, may require further adjustments to policy,'' Plosser said in a speech in Gladwyne, Pennsylvania, adding that he already expects several ``sluggish'' quarters of growth, Bloomberg News reported.

However, Plosser also told Reuters that he's "concerned that developments on the inflation front will make the Fed's policy decisions more difficult in 2008."

The Fed's preferred measure of consumer prices has risen 2.2% on a November 2006-November 2007 basis, or at a rate above the Fed's comfort zone, leading many economists to argue that the Fed may not be as stimulative as it typically would be at this stage of the economic cycle. The Fed may also continue to use non-interest rate policy options to encourage economic activity, these economists say.