The financial markets were disappointed by the Fed’s decision to postpone tapering, but so too were other central banks, which may now have to ease their own policies to combat fast-rising currencies.

Investors sold the US dollar (USD) aggressively on Wednesday, but less than 24 hours after the Federal Reserve decided not to taper asset purchases, the greenback recovered all of its losses against the Japanese yen (JPY) and is trading higher against the British pound (GBP).

Meanwhile, the euro (EUR), Swiss franc (CHF), New Zealand dollar (NZD), and Canadian dollar (CAD) all extended their gains, but the moves have been modest.

While the weakness in sterling can be attributed to softer UK data, the rapid-fire recovery in USDJPY may have caught some traders by surprise. New highs in the Nikkei helped to lift all of the JPY pairs, but the prospects for more stimulus from the Bank of Japan (BoJ) are also weighing on the currency. BoJ member Takahide Kiuchi said the central bank could be influenced by external factors such as market expectations, and will be forced to respond accordingly.

It should be no surprise that the actions of the Federal Reserve can have global repercussions. When Fed Chairman Ben Bernanke talked tapering in July, it drove global bond yields higher, creating a headache for other central banks.

Now, the decision to delay a reduction in asset purchases can also pose a problem for central banks including Japan, Australia, and New Zealand, which may have been banking on dollar strength to ease pressure on their own currencies. If those foreign currencies continue to strengthen versus the dollar, the central banks may have to offset the drag on the economy with easier monetary policies.

This morning's US economic reports were relatively good, which should support Bernanke's thesis that if the Fed keeps the QE pedal to the metal, the recovery should solidify and gain momentum. Manufacturing activity in the Philadelphia region expanded at its fastest pace since March 2011, while leading indicators rose 0.7%, and existing home sales grew 1.7%.

The country's current account deficit also narrowed to -$98.9 billion, its best level in 11 years. Jobless claims rose less than expected, but the Labor Department said the data continues to be distorted because two states are still working through a backlog of applications after computer system upgrades. In all, however, the data was better than expected, keeping the dialogue about Fed tapering this year alive.

UK Data Halts the GBPUSD Rally

Meanwhile, weaker UK retail sales data has made the British pound today’s worst-performing currency so far. Consumer spending dropped 0.9% in the month of August, and while the contraction in spending reported by the British Retail Consortium signaled that retail sales could be weak, few expected the largest decline in ten months.

The pullback in demand can be blamed on food sales, which soared in July, but plunged in August. If consumer spending fails to recover significantly in September, retail sales could subtract from GDP growth in the third quarter.

Considering that there are no major UK reports expected on Friday and none scheduled for release next week, the decline in consumer spending could cap GDP gains in the near term, or at least limit its rise relative to other currencies. However, if the UK PMI reports due the first week of October confirm that the recovery still underway, we could see renewed GBPUSD gains.

By Kathy Lien of BK Asset Management