What'll Fed Minutes Do To USD?

The dollar is trading lower this morning against all of the major currencies ahead of today's key U.S. event risk. While there has been a bit of volatility in the FX market, the equity and bond markets traded quietly since the beginning of the week as investors wait for the release of the FOMC minutes and for Bernanke to speak. Given that little time has past since the last Fed meeting and economic data has been mostly better than expected, there's a good chance Bernanke's comments and tone will be unchanged. The FOMC minutes should contain some optimism because the central bank lowered their unemployment forecasts. Also at the June Fed meeting, the Fed Chairman was very vocal about reducing asset purchases and we expect Bernanke to reaffirm these plans. Considering the significance of the shift in Fed policy a repeat of their plans to begin tapering this year and end asset purchases completely in 2014 could be enough to renew the rally in the dollar. However, new highs in the greenback would probably require a sign of significant internal support for changing their current monetary policies in September versus December.

Tapering vs. Rate Hikes
That said, Bernanke could still spend time stressing the difference between tapering and rate hikes. Just because the central bank is getting ready to reduce asset purchases does not mean they are anywhere close to raising rates. While this may be obvious to some investors, the sharp rise in U.S. yields suggests that the market is pricing in tighter monetary policy. The market to watch today will be bonds. If the FOMC minutes or Bernanke's speech drives U.S. yields higher, the dollar will follow but if bonds hold steady, the dollar may not see much momentum.

The exit is clearly marked so even if the FOMC minutes reveal nothing new, the divergence in global monetary policies should keep the dollar bid. For the minutes to be overwhelmingly dollar positive, we need significant support for tapering in September. There are only two real opportunities for the Fed to take action this year -- September and December. As this is a major monetary policy shift Fed Chairman Ben Bernanke will want to clarify the central bank's position and press conferences are scheduled after both meetings. If the Fed believed that the economy could handle it, they would much rather taper for the first time in September than December because the December meeting is too close to the holidays.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.