USD Rallies On FOMC Minutes, Dollar Index To Maintain Trend

The U.S. dollar pared the overnight decline, with the Dow Jones-FXCM index bouncing back from a low of 9604.27, and the rebound may gather pace going into the end of the week as the Federal Reserve changes its tone for monetary policy. The index is 0.21% higher on the day after moving 94% of its average true range, and the gauge looks poised to test 9750.00 over the coming days as it continues to trade within an upward trending channel. However, as the relative strengthen index approaches oversold territory, there is likely to be a small pull back before we see the dollar index continue to retrace the decline from the previous month.

The majority of the FOMC said they favored raising the benchmark interest rate before unwinding its asset purchases, with the group debatinga possible exit strategy at the policy meeting earlier this month. However, the Fed went onto say that the recent discussion should not be interpreted as an imminent tightening in monetary policy as the committee continues to see a “moderate” recovery in the world’s largest economy. The minutes revealed that QE3 remains off the table unless there’s a marked shift in the economic outlook, and noted that the first step to normalizing monetary policy would be to cease MBS reinvestment. In terms of growth and inflation, the central bank argued that the rise in price growth is likely to be transitory, while policy makers expect unemployment to gradually decline given the ongoing weakness within the private sector. The comments suggest that the FOMC will continue to support the real economy as QE2 expires in June, and the committee may preserve a wait-and-see approach in the third-quarter to encourage a sustainable recovery.

All four components weakened on Wednesday, led by a 0.65% decline in the British Pound, and the sterling may continue to underperform against its major counterparts as the Bank of England maintains a cautious outlook for the U.K. In light of the recent developments, the GBP/USD certainly remains at risk of facing additional headwinds over the near-term, and the exchange rate looks poised to fall back towards former resistance around 1.6000 as it searches for support. However, as price growth in Britain accelerates, the heightening risk for inflation could fuel bets for a rate hike later this year, and interest rate expectations should help to prop up the sterling as market participants weigh the prospects for future policy. According to Credit Suisse overnight index swaps, investors see borrowing costs in Britain increasing by nearly 50bp over the next 12-months, and interest rate expectations may gather pace in the second-half of the year should the BoE toughen its stance against inflation.

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