One of the most important questions that many traders have in mind with respect to the price of USD is about the direction of the federal funds rate. Indeed, given the overwhelming, and increasing dominance of the Dollar as the international measure of value, one can easily create a scenario tying the fate of the global economy to dollar, at least at the highest zoom level. Trends in U.S. interest rates have a clear and easily observed relationship to everything from global trade volume, to the Baltic Dry Index, stock prices, or to the price of gold.

So when exactly will the Federal Reserve begin to raise interest rates? Sixth months later? One year? Or two years? That is the million dollar question, but we believe that the answer is not that difficult to uncover at all. It is easy because the answer is only known to a single entity comprised of a few people who go to great lengths to make their opinions known to the public. You, or the head of a government, or an economist may have great solutions and insight into many problems faced by the global economy, but unless they are shared by Ben Bernanke and his team, they are totally irrelevant to our appraisal of dollar trends.

The Federal Reserve is an independent institution. It is legally, and practically free from external interference, and indeed it would appear that it has more influence on the government than a case of total independence would imply; the government respects and abides by the direction set by the central bank, and not vice versa. But although in theory this means that we are completely at the mercy of the Board of Governors, and the FOMC, with respect to the direction of monetary policy, it does not mean that we need to acquire skills of telepathy or mind reading in order to guess, reliably, what kind of action the Federal Reserve will take in the future.

There are a number of reasons that make predicting the Fed's course possible.

The Fed has a legal mandate, and responsibility.

As most people know, the Fed must balance its dual goals of achieving full employment and restraining inflation while setting monetary policy. In other words, its commitment to its goal of keeping inflation below 2% is only half of the picture. The institution is required, by law, to overlook a period of higher than desired inflation if the employment situation of the country justifies it. In fact, over the past 10 years or so, the average inflation in the U.S. has been around 3%, a full percentage point above the declared target of the institution.

Over the years, under Mr. Greenspan and Ben Bernanke, the Federal Reserve has in fact moved strongly towards the purpose of focusing entirely on inflation, with the tacit understanding that it can keep unemployment low best by keeping inflation low in the first place. But although it is easier to abide by this principle in times of boom, the immense political, moral, and public pressure to "do something" at times of calamity makes it extremely difficult for the institution to pursue this ideal.

It is run according to the teachings and analyses of Milton Friedman.

To put it shortly, Milton Friedman believed that the Great Depression was caused by the Federal Reserve not printing enough money to inflate the economy and to restore confidence by preventing chain bankruptcies in the 1930s. A very crude, but not far off-the-mark restatement of his ideas, for our purpose, is that one can solve any confidence crisis by throwing large quantities of money at the problem. It is as if saying that any economic problem is, at its heart, a psychological problem, and can be managed through the management of perceptions, with fundamental value having only limited relationship to economic trends.

It is chaired by Ben Bernanke.

Ben Bernanke has declared on many occasions that he endorses Friedman's version of events to the full, and will never allow a second "Great Depression" to occur again. He has stated in articles written during the short 2001 deflation scare, and later, that it is near impossible to have deflation in the U.S. because the Federal Reserve will do "whatever it takes" to prevent this from happening. The phrase "whatever it takes" is in fact a favorite one of the Fed Chief, and he has shown repeatedly that he is not joking, by expending, or endorsing the spending of hundreds of billions of public dollars in a quest to prevent a repeat collapse of the financial system.

In order to understand the meaning and essence of the monetary policy pursued by the Federal Reserve, we must recall that no one possesses the kind of mathematical certainty in an economic decision that a physicist or chemist enjoys while predicting or measuring any natural event. The Fed believes in certain theories, and it is merely applying them, at the moment, with the hope that the remedies suggested by them will be strong enough to resolve our problems. This is not a mistake, in the sense that the path taken by them represents the opinion of the majority in the academic world. But there is no guarantee that they are appropriate, or will deliver in the long term. Thus, we do not need to know what is the correct policy (which is much harder to do), but only what is believed to be right, which is not difficult.

So, where should we expect monetary policy to head in the next few years, on the basis of the points made above? Let's make a brief summary of facts as they stand at the moment.

Unemployment is close to 10 percent.

Capacity Utilization is at 74.7 %. This is just one percent above the 2001-2002 low, and a full six percentage points below the long term average of 80.6%, registered in the period 1972-2009. It is highly unlikely that inflation will materialize in such an environment in consequence of domestic pressures.

Dollar is strengthening. With the collapse of the Euro, there is practically no alternative at all to the USD for the foreseeable future, which supports the currency's value, and diminishes external inflationary pressures as well.

Demand for Loans is still very Low. Although demand has been picking up, it is generally thought that this is a consequence of the various government initiatives, including subsidies and tax cuts, and does not represent a fundamental improvement in perceptions. In any case, demand for consumer credit has been falling for many quarters, and it is mostly exporters and manufacturers that contribute to loan demand on the large scale.This is unlikely to continue because external demand is riding a very large number of bubbles. One must be sobered by the fact that there is a raging real estate bubble in Israel at the moment.

Both Consumers and the Corporate sector are under a huge debt burden. Especially small and medium-size enterprises, which have limited access to international markets, will have great difficulty in meeting obligations if rates rise while demand is falling or stagnant.

What is the sum of all these facts? We know that the Fed can't raise rates for at least the next 12 months, even under the most optimistic scenario, barring the cataclysmic case of a U.S. sovereign debt crisis, which is clearly unlikely at this stage. Inflation is simply not a problem at the moment. If we add unemployment to the picture, we can safely delay the first rate rise into Q4 2011. But that, of course, depends on the hypothetical scenario of external demand picking up, and sustain U.S. exports, while the real life outcome is likely to contradict this expectation. And what about dollar demand in the rest of the world which is prone to spike as concerns about sovereign credit increase? Can the Fed afford to raise rates, increase the value of the dollar, dampen the manufacturing sector, and place the banks of Europe in great trouble by making Dollar-denominated obligations far more expensive to meet?

In conclusion, we believe that rates in the U.S. will remain around these levels for at least until the end of Barack Obama's term, and indeed,with Mr. Bernanke at the helm, we expect them to remain close to zero until the Central Bank is forced to raise them by market forces. This is not a good choice, of course, but it is the choice made and communicated by the Federal Reserve on many occasions, and the best course for traders is not discussing the wisdom of the Fed, but finding ways to exploit it profitably in the meantime, however incredibly wrong it might appear at times.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.