The minutes from the last FOMC meeting is scheduled for release today and FX traders are gearing up for a potentially big reaction in the forex markets. Given our experience, we have seen lofty expectations disappointed on more than one occasion and we would not be surprised if the minutes did not provide the clarity that everyone is looking for. Even up to the July meeting, Federal Reserve officials were divided on how quickly tapering should occur and it is very possible that the minutes will show a significant amount of debate within the central bank causing more confusion than clarity. There is a lot less dissent on the idea of changing monetary policy before the end of the year but with only a month to go before the key Fed meeting, the heightened sensitivity to anything that could shed light on the timing for Fed tapering and lower liquidity in August implies that it may not take much to move the U.S. dollar.

Here’s a look at 3 possible scenarios for today’s FOMC Minutes:

Scenario #1 – Fed Emphasize Economic Progress, Talks of Tapering Treasuries & MBS > Bullish USD and Yields

The first thing that we will be looking for in today’s release is the level of conviction for easing in September. Most Federal Reserve Presidents that we have heard from support some type of action over the next 3 months with more leaning towards a move sooner than later. If the minutes emphasize the progress made in the U.S. economy and the need to act quickly, U.S. dollar and U.S. yields could extend their gains with EUR/USD dropping below 1.3350 and USD/JPY hitting 98. We will also be looking for details on which assets the Fed will taper. The choice is between Treasuries and mortgage backed securities and if the Fed talks about reducing purchases of both, it should be supportive of both the dollar and yields because it represents a more aggressive and broad based reduction. If the central banks provide any specific number in terms of the amount of bonds reduced, it could also rally the dollar.

Scenario #2 – Fed Cautious, Signals Potential for Delayed Move, Talks of Tapering only Treasuries > Bearish USD and Yields

However if the minutes contain an overall air of caution with more FOMC officials screaming about the need to wait for further improvements before changes are made, fueling speculation for a December over September move, the dollar could fall sharply as investors readjust market expectations and U.S. yields decline. At the same time, if the Fed suggests that their focus is on reducing Treasury purchases, we expect the dollar to weaken as this would represent a smaller and less aggressive initial move. For the EUR/USD, this could mean a rally back to 1.3450 and for USD/JPY, a break of 97.

Scenario #3 – Divided Fed, No Operational Details on Tapering > Bearish USD and Yields

The third scenario is also negative for the dollar and would involve significant dissent within the FOMC and no operational details on tapering that suggests the central bank hasn’t ironed out their plans. A lack of even minor consensus is bad news for the dollar because it would increase the chance that the Fed will have to postpone their move to December. Also, traders should watch for any qualifying statements that suggest a move this year would be incremental or one-off and not the beginning of a broader trend.

Given recent U.S. data disappointments, we feel that Scenario #2 and #3 is more likely even though we still believe the chance of Fed tapering is higher for September than December. July would have been too early for some members to commit to any move. A number of Fed officials may have wanted to see how non-farm payrolls and retail sales fared over the next 2 months before solidifying their decision. U.S. existing home sales will be released before the FOMC minutes but the impact on the dollar should be minimal as investors wait for today’s key event.

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