The Fed will release the minutes from the January FOMC meeting on Wednesday at 1900 GMT, and investors will be watching closely as they try to gauge whether the central bank will chart a more hawkish course moving forward. While an optimistic tone in the minutes may help the dollar to extend its latest recovery, it is critical to keep in mind that the broader market narrative remains one of USD weakness, for now at least.
While the Fed kept borrowing costs unchanged back in January, the accompanying statement was interpreted as having a hawkish tilt. Policymakers upgraded their language around inflation, and appeared more upbeat on the broader economy. Perhaps more importantly, they altered slightly their assessment over the future course of interest rates. The word "further" was added to the sentence "The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate". This subtle change was widely seen as a preliminary sign that the FOMC is contemplating the prospect of more rate hikes in the future, something that investors will be looking to confirm through these minutes.
At the time of writing, markets have fully priced in two quarter-point Fed rate hikes this year, and also see a 70% probability for a third one, according to the Fed funds futures. In case the minutes echo an equally optimistic tone as the statement, the probability for a third hike could move closer to 100%, and investors may even price in some expectations for a fourth one. Such an outcome would likely help the dollar to extend its latest rebound. Dollar/yen is likely to move higher in this scenario and break above its latest highs at 108.00. Such a break could open the way for a test of the 109.30 resistance territory, marked by the peaks of February 9.
On the contrary, if the minutes fail to live up to the hawkish expectations and instead appear to be relatively neutral or cautious, then the dollar could resume its broader downtrend. Dollar/yen may inch lower and test the 106.80 support zone, identified by the lows of February 14. If sellers prove strong enough to overcome that barrier, then the pair could gradually aim for a test of 105.50, the low it posted on February 16.
All the above said, it is critical to remember that the bigger story remains one of USD weakness, amid elevated concerns regarding widening US deficits and longer-term debt sustainability. Thus, even in case the dollar spikes higher on the minutes, it remains to be seen whether it can maintain the positive momentum. It may take something more than just a slightly hawkish tone in these minutes for this narrative to change, and for the dollar’s downtrend to reverse.
In this respect, markets will pay very close attention to Jerome Powell’s testimony before Congress next week. The testimony of the new Fed Chair will not only shed some light on his own views, but may also provide markets with some commentary on the encouraging developments that happened after the January meeting and hence will not be discussed in these minutes. For instance, how the Committee views the acceleration in wages and the stronger-than-anticipated CPI numbers for January. Powell’s comments could be the biggest determinant of expectations over what the Fed is likely to deliver this year and thus, the dollar’s overall direction.
