I have been critical of the Fed's rate-slashing campaign between September and April. Rather than supporting the economy, the cuts have undermined the dollar and boosted commodity prices, thereby increasing inflationary risks. Fed Chairman Bernanke’s musings this week on the desirability of a stronger US currency appear to represent belated acknowledgement of such criticisms.

Talk is cheap but is the Fed prepared to adopt policies to support the dollar? As the first chart below shows, the US trade position is improving relative to Euroland, laying one of the foundations for a recovery in the dollar versus the euro. However, it may be difficult for the currency to achieve a meaningful gain given the large gap between real policy interest rates in the US – now negative – and Euroland.

One indicator that has provided advance warning of Fed policy shifts historically is the ISM manufacturing delivery times index. Lengthening delivery times signal rising pressure on supply capacity, which may warrant Fed tightening. The index has recently moved into the region associated with rate increases – see second chart. With this indicator and the dollar both suggesting tighter policy, will the Fed move quickly to withdraw stimulus if the economy recovers in the second half, as seems plausible?