Up until the release of the minutes from the most recent Federal Reserve monetary policy meeting, it had been a very quiet trading day. It's not often that the FOMC minutes will cause a large reaction in currencies, but the fact that the dollar soared minutes after the release to a two-year high against the euro goes to show how easily swayed investors are when it comes to signs of QE vs. no QE.
In today's case, the FOMC minutes were just not enough to satisfy QE3 traders who wanted a more explicit admission that further asset purchases would be necessary. A few FOMC members felt that more stimulus could be needed, but this wasn't any different from what they said back in April. The same is true of the warning that they are prepared to take further action as appropriate. While Federal Reserve officials are clearly worried about the state of the U.S. economy and the outlook for China, their call for a study on "new tools for easing" suggests that they want to look for other options beyond quantitative easing. In a nutshell, the Federal Reserve isn't committing to anything and keeping all of its options open, which was enough to squeeze the dollar higher.
Does this mean that QE3 is off the table? Absolutely not.
While the monetary policy committee felt that the economy continued to expand moderately between April and June, they admitted that the gains were smaller than anticipated and there is unusually high uncertainty for jobs and growth. Some FOMC members also believed that there could be a significant slowdown in China that could deal a blow to the export sector. Their decision to revise down their growth forecasts were motivated by a slower pace of job growth, weak retail sales, a lower trajectory for personal income, and weaker exports.
The prospect of further uncertainty in Europe and tighter domestic financial conditions also contributed to their decision to downgrade their GDP forecasts. The FOMC minutes may have helped the dollar by shaving the chances of QE3, but we don't believe that everyone have given up on the idea of more stimulus. For this reason, every piece of incoming data this week and next -- including tomorrow's import prices and weekly jobless claims report -- could still trigger big moves in the greenback as traders adjust their QE expectations.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.