Montreal, Canada

The Federal Reserve surprised most market participants with a sudden hike in the discount rate yesterday after the markets closed. Stock futures immediately declined as bond yields shot significantly higher from about 3.70% to 3.80% on the benchmark ten-year Treasury bond.

Calm has been restored this morning and bonds are trading slightly higher.

The discount rate is the interest rate the Fed charges member banks for loans, using government securities or eligible paper as collateral. The discount rate is effectively what the Fed uses to put a floor on interest rates.

There's no need to breakout the alarm bell just yet. But if you watch the financial news, namely the wildcats on CNBC, you'd think the world was coming to an end. CNBC is probably the worst place an investor can get advice.

The Fed is a long way from moving to seriously curb liquidity amid an environment of fractured credit intermediation, a tepid housing recovery and high unemployment. Thursday's move was the right thing to do as the Fed attempts to withdraw emergency liquidity measures put into place starting in 2008. This was not a rate hike in the traditional sense. It's just a normalization process.

The dollar, meanwhile, is clearly in a recovery since late November.

The U.S. Dollar Index has busted through important resistance levels recently and is taking many currencies to the cleaners – namely the EUR. Speculators who began the year with heavy bets against the dollar have been forced to cover their shorts or file for unemployment. The rally has been swift and formidable in a short period of time.

I suspect the Fed will only commence raising the Federal Funds rate later this year and only if the unemployment rate declines. The key to the dollar is U.S. employment growth; if the United States doesn't grow jobs then this rally will end badly – and stocks and commodities with it.

Bernanke, who passionately studied the consequences of botched U.S. monetary policy in the 1930s, won't be in a rush to hike lending rates.

The Fed, starting in 1936, began to raise interest rates at a time when GDP was recovering sharply along with a boom in stocks off the June 1932 lows. That series of interest rate hikes was a fatal error as equities and the rest of the economy began a second tailspin starting in 1937. Bernanke knows this all too well and won't be in a hurry to tighten. Even if he does, we're starting from such a low base – effectively at zero percent – that the market is unlikely to fall apart for a while until rates ratchet much higher.

A model for the market might be 1994 when the Greenspan Fed (or Bubble-Boy Alan) began to hike the Fed Funds in March of that year. Rates had been super-low coming into 1994 following the S&L bust and a major U.S. dollar bear market. Like now, the dollar was a joke, mocked by the popular press, most investment newsletters and declared good as dead. By the summer of 1995, however, the dollar had bottomed and, under the Clinton-Rubin years, was well on its way to a bull market until 2001.

This time might not be that different.

However, unlike 1994 we're coming out of a credit-inflicted shock that still has widespread reverberations across credit intermediation and securitization. Many traditional or pre-2008 credit channels aren't working and the ones that are require Federal assistance to this day. Also, the United States is enormously in debt in 2010 with debt auctions the size of Mars every week while harboring massive budget deficits since 1999. The U.S. has lost control of its finances.

The dollar will enjoy a bounce. But in no way does this mark a new secular bull market for the American dollar or any other currency for that matter, as the markets challenge sovereign debt and its borrowing limits this year. This is not 1994 but more like 1936-1937.