The Fed will release the minutes of its May policy meeting on Wednesday, at 1800 GMT. Markets will likely look for insights on whether policymakers are willing to allow inflation to overshoot its 2% target without raising rates for a while, something they teased in the statement. A confirmation could push back on speculation for faster hikes this year, and perhaps diminish some of the dollar’s appeal.
The Fed sent mixed messages when it kept interest rates unchanged in May, sending the dollar into a spin. Recall that this was one of the “small” meetings without a press conference or updated forecasts, so the only thing market participants had to go on was the statement accompanying the decision. It contained three notable changes.
With respect to inflation, officials added the word “symmetric” when describing their 2% inflation target, which was taken as a signal the Committee may be willing to allow inflation to run above 2% without raising rates for a while, since it was running below it for years. Policymakers also removed from the statement a phrase that previously said they are “monitoring inflation developments closely”, providing another hint that they are becoming more confident inflation will rise. In other words, inflation is about to pick up, but the Fed is unlikely to act on that, for now at least.
Meanwhile, the Committee also erased a sentence that stated: “the economic outlook has strengthened in recent months”, acknowledging economic data had started to moderate and that growth may have lost some momentum. Putting these together, officials appear to have become more cautious about the economy’s performance, but more optimistic on the prospects for inflation.
Looking at what is priced into the markets, investors are still split on whether the Committee will deliver two more quarter-point rate hikes in 2018, or three. Two more hikes are already fully priced in, while the Fed fund futures indicate a 35% probability for a third one. Against this backdrop, market participants will scrutinize the minutes for any fresh hints that show a preference towards one of these outcomes, and the dollar will probably move accordingly; higher on anything suggesting three more hikes, and lower on signals indicating two more.
For example – if the Committee clearly emphasizes its willingness to tolerate an inflation overshoot, then the dollar could weaken as hopes for three additional hikes fade. Taking a technical look at dollar/yen, immediate support to declines could come around 110.55, the trough of May 18. A downside break of that level could pave the way for the psychological number of 110.00, with even further bearish extensions potentially aiming for 109.15, the May 11 low.
On the other hand, if the Fed downplays the importance of the word “symmetric” as not necessarily implying it will sit idle while inflation spikes above 2%, that could stoke fresh speculation for three more hikes, and bring the dollar under renewed buying interest. Advances in dollar/yen may encounter initial resistance near 111.40, the zone that capped the pair’s ascent on May 21. If the bulls break above it, then the round figure of 112.00 could come into play, marked by the low of January 2. A clear and decisive break above that area too could open the way for a test of the 113.40 hurdle, defined by the peak of January 8.
Besides the minutes, the other potential market mover for the greenback this week will be a public appearance by Fed Chair Jerome Powell on Friday at 1420 GMT. As is the case with the minutes, anything from him that tilts the scale towards a third hike could benefit the dollar, and vice-versa.
