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Cautious optimism.

That’s all we’ve been seeing from Fed officials the last few times a FOMC statement has been released. They’ve basically said, “Yeah, things are looking up but we wanna keep a short lease on this so that we stay in control… You never know what might happen.” Most analysts expect the same from Fed Chairman Ben Bernanke and his merry policy makers this time around…

The results of the FOMC meeting however, may end up having a huge impact on the markets. With 2009 coming to an end, I suspect that FOMC members will start discussing the development and progress that the US economy has made in overcoming the recession. The possibility of specific exit measures, as well as the schedule for a potential rate hike is certainly there.

More talk of exit strategies?! Why not? Recent economic reports, particularly employment and consumer spending data, seem to indicate that an economic recovery is starting to unfold. Just last week, US retail sales chalked up their biggest increase in four months. Retail sales climbed 1.3% in November, exceeding expectations of a 0.6% uptick. Much of the increase in sales could be attributed to seasonal holiday spending – I’m talking about the Thanksgiving and early Christmas shopping spree – but the significant rise in consumer spending would probably be reason enough for the Fed to be a little more upbeat this time…

And who could forget that NFP surprise we saw a couple of weeks ago? The NFP report printed only 11,000 in net job losses, effectively bringing the unemployment rate down from 10.2% to 10% in November. This was definitely good news for the US labor market! Although President Obama remarked that “the good trend does not pay the rent,” this improvement in employment may be too strong for the Fed to ignore.

And what would an upbeat statement mean for the dollar? Well, if recent market movements are any indication, it could once again boost sentiment towards dollar! take note, when the NFP report was released, the greenback made a huge comeback. And it was not just a simple comeback… within the course of the day, the beloved EURUSD shot down 280 pips, moving contrary to the usual risk appetite-aversion flows. This caught a lot of traders off guard as positive economic numbers tend to be bearish for the dollar. Talk about making a statement!

The recent jump in US retail sales also sported a significant boost for the dollar. Much like what happened during the NFP release, the EURUSD unexpectedly fell around 180 pips when the retail sales report came in with a higher increase than expected.

The market appears to be out of sync these days… Is a positive correlation between economic strength and the dollar developing?

In my humble opinion, in order for the dollar rally to continue, the US needs to keep on printing “strong” data, especially those that deal with employment and consumer spending. These are things the average Joe can relate with and continuous improvement in these sectors would give them the confirmation they need to lift their spirits and restore their confidence on the US economy.

More than that, however, the Fed needs to create the perception that they aren’t going to keep their monetary policy at ultra accommodative levels forever. I mean, look at how the dollar rallied last week when the there was all this talk about the Fed raising rates come 2010! It doesn’t matter if inflation has yet to pick up or if lending remains tight, what’s important is that the Fed creates the illusion that they do care about the ridiculous amount of money they printed to combat the recession and that they will, eventually, do something about it.

With that said, look out for some aggressive comments by FOMC officials come Wednesday. No more beating around the bush and taking a passive stance this time. Watch out for some early fireworks and be ready – the upcoming FOMC statement could set the tone for 2010.