As expected, the Fed opted yesterday to leave the target for Fed funds unchanged at 2.0%. Subsequently, changes to the policy statement have received extensive scrutiny in an effort to determine when and if the Fed will raise interest rates in an effort to get inflation in check.

The recent pullback in energy prices probably provided the Fed with a little breathing room, yet they still ratcheted their inflationary concerns higher in the statement:

"Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain."

Adding, "Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee."

Worthy of note is the addition of "significant concern." A subtler difference is the fact that they led off their comments on inflation with the very direct statement, "Inflation has been high."

In the June statement, the inflation paragraph began with, "The Committee expects inflation to moderate later this year and next year." That statement was relegated to the end of the paragraph this time around.

Heightened concerns about inflation come as no surprise. Chairman Bernanke was obliged to offer FOMC hawks some concessions in the statement, or risk additional dissent. Like in June, the lone dissent vote came from the Dallas Fed's Richard Fisher. Without the stronger statement on inflation, there was the risk that Philly Fed's Plosser and Minneapolis Fed's Stern might have cast dissenting votes as well.

At this juncture the Fed has enough credibility issues. Three dissents to policy would have been extremely problematic for Chairman Bernanke.

The Fed did not completely ignore persistent risks to growth: "labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters."

However, the most telling change between the June statement and the August statement with respect to downside risks to growth was the omission of "appear to have diminished somewhat."

Ultimately it seems that the Fed has increased concerns over both price risks and growth risks. We ended up with a mixed reaction in the market with stocks rallying on expectations that the Fed won't be raising interest rates any time soon. At the same time, the dollar remained firm within its range, presumably due to expectations that deteriorating economic conditions elsewhere in the world will prevent interest rate differentials from widening further.

The retreat in energy prices in recent weeks is likely to provide the ECB with the necessary cover to hold the refi rate steady at 4.25% tomorrow. The BoE will likely leave the base rate unchanged at 5.0% as well.

Note that yields in the Eurozone and the UK are more than twice the available yield in the US. Flows in the FX market tend to follow yield, so present interest rate differentials do not bode well for the dollar.

Despite the uptick in inflation concerns, Fed funds futures are viewing the FOMC's statement as more dovish. Rate hike expectations that emerged in June following extremely hawkish comments from Mr. Bernanke continue to get reversed out. Odds of a 25bp rate hike by the end of Q3 have diminished to just 12%. Meanwhile, odds of such a tightening by year-end are now just 54%.

We have consistently maintained that the Fed would continue to focus on risks to growth and employment at the expense of higher inflation. It simply doesn't make sense to raise interest rates, while simultaneously flooding the market with liquidity in an effort to prevent a collapse of the banking system.

Higher interest rates would also kill demand in an already disastrous housing market. The root of the current economic turmoil is the deflation of the housing bubble. The situation is unlikely to stabilize until housing finds a bottom, so it seems extremely unlikely that the Fed would thwart efforts to bolster housing by raising rates.

The bottom line is that easy and expansionary monetary policy is here to stay for some time. As a result, the upside in the dollar is likely to be limited. At the same time, inflationary pressures are going to remain stubbornly high, despite the pullback in commodity prices.

The best way to protect yourself against a weaker dollar and the resulting inflation, along with persistent risks to the banking system is to own physical gold. Gold offers non-correlated diversification and an excellent means of wealth preservation within the contemporary portfolio.

The first chapter of The ABCs of Gold Investing, the book written by the president of our firm, ends with this: "No matter what happens in this country, with the dollar, with the stocks and bond markets, the gold owner will find a friend in the yellow metal -- something to rely upon when the chips are down. In gold, investors will find a vehicle to protect their wealth. Gold is bedrock."

Gold Market Movers:

EIA crude oil inventories at 10:30 EDT.

US MBA mortgage market index for the week ended 01-Aug +2.8%; purchases +1.8%, refis +4.4%.

German orders for Jun fell 2.9% m/m, much worse than the market was expecting. The seventh consecutive monthly decline.

Japan leading index for Jun -1.7.

Freddie Mac sinks to $800m loss

Economic free fall?

How Merrill trampled the little guys

The recovery and the storm

US urges 'punitive' steps on Iran