As was widely expected, the Federal Open Market Committee left its target fed funds rate unchanged at Tuesday's policy meeting. Somewhat unexpectedly, the FOMC said the risks are weighted toward economic weakness, which put additional pressure on an already sinking dollar.

After punting on the risk-assessment statement in March, the FOMC surprised some market participants by reinstating it Tuesday with a bias toward economic weakness.

"The Committee perceives that over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal," the statement said. "In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals is weighted toward weakness over the foreseeable future."

In reaction to the Fed's announcement at 2:15 p.m. EDT, major stock proxies immediately fell from earlier highs, then rallied to intraday peaks before retreating again. After trading as high as 8641.22, the Dow Jones Industrial Average closed up 0.67% to 8588.36. The S&P 500 finished higher by 0.85% to 934.39 vs. its intraday best of 939.61, while the Nasdaq Composite closed up 1.31% to 1523.71 vs. its apex of 1531.80.

Treasuries rallied in reaction to the Fed announcement after struggling early following poor demand for the three-year note auction. The benchmark 10-year note ended up 22/32 to 100 2032, its yield falling to 3.77%.

The dollar, which was getting pummeled prior to the Fed meeting, weakened further, with the euro breaking through the $1.14 level vs. $1.1365 shortly after 2 p.m. EDT. The dollar also weakened vs. the yen and other major currencies. Late in New York trading, the euro was at $1.1438.

The Fed's statement hinted that more rate cuts may be forthcoming, which would further undermine the dollar's relative attractiveness to foreigners. The European Central Bank's target rate, for example, is currently double the Fed's current target of 1.25%; this yield discrepancy now seems likely to be expanded in the coming months.

But "the lack of attractiveness of the dollar is underlined by the fact that the currency stands unlikely to reverse its gloom, regardless of whether the Fed had signaled a move in the near term or not," according to Ashraf Laidi, chief currency strategist at MG Financial Group. " Tuesday's decision signals that the Fed is a step closer to resorting to its emergency liquidity driving measures, a possibility that portrays the path towards economic deterioration."

In that light, Laidi noted that the committee's concern about "an unwelcome substantial fall in inflation" is the first time the FOMC has referenced deflation in its policy statement, "a stark shift from its repetitive playing down of deflation risks since the Fed inaugurated its easing monetary policy in January 2001."

Whether it could have done anything to aid the dollar is debatable. What's more obvious is the Fed didn't want to do anything to help the greenback.

The Big Bet

"A weak dollar plays a supporting role in the growth outlook -- they acknowledge that and support it tacitly if not otherwise," observed William Sullivan, senior economist at Morgan Stanley. "They will not implement policies designed to support the dollar, and will tolerate a weaker currency, because it helps their goal of long-term economic growth."

Sullivan conceded the bearish concerns about further dollar weakness leading to an exodus of foreign capital are "not misplaced," especially given the yawning current account deficit. (On Monday, the Treasury Department reported that net foreign purchases of U.S. stocks and bonds fell 31% to $23.8 billion in February, the third straight monthly decline.)

But while some see the Fed whistling past the dollar debacle, Sullivan sees a method to the apparent madness.

In its statement, the Fed cited "recent readings on production and employment" as being particularly disappointing, the economist noted. He suggested this means the central bank is particularly concerned about ongoing weakness in the manufacturing sector. In the April payroll report, manufacturers cut payrolls by 95,000, the 33rd consecutive month of contraction in the beleaguered sector.

It's a "back-door approach," but a "turnaround in manufacturing could be achieved by devaluing the currency," Sullivan said. The economist further suggested that other industrial nations would "favor a weaker dollar," because reinvigorating economic growth here is more important than their immediate desire to export their products to the U.S., which a falling dollar hampers.

"Expansion here would have an echo impact," Sullivan said.

The Fed, in concert with the Bush administration, seems to be betting that the dollar's fall can be managed and the salutary effects of a gradual decline will kick in rather than the more draconian impact of an accelerating dollar decline.

As with life, it turns out running the global economy is a gamble, after all.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.