Should you buy or sell the US dollar ahead of the FOMC Minutes?

Financial markets are quiet today as US banks are closed due to the Presidents Day holiday. As such, market participants have plenty of time to prepare for the economic events scheduled later in the trading week.

One, in particular, is critical for the US dollar’s direction – the FOMC Minutes. Scheduled on Wednesday, the minutes will reveal what the FOMC members discussed three weeks ago when the Fed decided to increase the funds rate by 25bp.

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Why are the FOMC Minutes important?

The Federal Reserve of the United States raised the funds rate aggressively in response to rising inflation. Lately, data suggests that inflation may have peaked and, according to the  Fed’s message, a disinflation process has started.

Markets have tried to time the Fed’s pivot from a hawkish to a dovish stand, but the Fed did not indicate that any pivot will come anytime soon. This is precisely why this Wednesday’s minutes are important, as they might suggest the Fed is approaching the terminal rate sooner rather than later.

How will the US dollar react?

The US dollar would sell off if the minutes reveal that the Fed is closer to the terminal rate. In fact, the dollar has already given up most of last week’s gains triggered by relatively hotter inflation in January than forecast.

The currency market always moves in anticipation of what central banks will do with the interest rate level. As such, it might be that the dollar’s weakness after the recent inflation report is just the start of a prolonged bearish trend.

If that is the case, then stocks should rally too.

A strong dollar has helped the Fed in its fight against inflation. Now that inflation is cooling off, the dollar’s strength may reverse, and we may see a continuation of the bearish trend that started last October.

All in all, the bias ahead of Wednesday’s FOMC Minutes is bearish on the dollar. The risk-on sentiment will dominate financial markets if the minutes lead to the impression that a pivot is close.