The Federal Reserve delivered its much expected 25bp interest rate hike today, bringing rates up to  5 percent.  To the shock of the market, the Fed did not tone down the FOMC statement significantly. They repeated that "some further policy firming may yet be needed" which suggests that Bernanke may be regretting his previous comments for a pause and probably feels that the dollar has sold off enough. Unfortunately traders tend to forget that a weak dollar also boosts inflation pressures by making imports more expensive, so the Fed is walking on a very fine tightrope.  They are  very close to being done with interest rate hikes but unfortunately today's rate hike is probably  not the last.  We still have two more CPI readings till the June meeting and as the Fed has said in their statement, the extent and timing of further increases will be data dependent. 

We are not done yet with market volatility and traders have bought dollars cautiously as they await the US Treasury's semi-annual FX report due at 4pm ET. We will be updating our comments shortly thereafter. The market is divided on whether the Treasury will brand China as a currency manipulator.  They are closer to taking this step than they have been in the past, but as people argue about the black and white scenario of whether China will have a new label, we wrote in yesterday's Daily Fundamentals the potential of a middle ground:

Everyone seems to be talking about either the black or white scenario, but it is just as likely for  the US Treasury to tighten up their stance on China without labeling them outright.  The last report  published in November 2005 applauded China for the changes that they made to their currency regime  last July.  At the time, they said that because of the move, they refrained from designating China  as a currency manipulator. So who is to say that rather than doing a complete about face, the US Treasury would not choose to revert back to the comments they made in May 2005.  They could just as  easily acknowledge China's steps towards moving to a more flexible system, but criticize them for  not doing enough and repeat that if they do not substantially alter their policies soon, they would  meet the Treasury's technical requirements for being designated as a currency manipulator.  The US  Treasury's report comes at a sensitive time politically where the US has an interest in drumming  Chinese support for a strategy in dealing with Iran.  Remember, the report is just as much political  as it is economic. Therefore, harshening their stance on China's policies without out rightly  branding them yet may be a good middle ground for the US at this point.

Kathy Lien is the Chief Currency Strategist at FXCM.