Recall that Fed Chairman Bernanke issued a less upbeat speech in last month's Congressional testimony, following a more optimistic January FOMC statement. Since the data have been markedly weaker since February, the Fed has no choice but to tone down the optimism in the phrase indicating "recent indicators have suggested somewhat firmer economic growth."

The dollar gains ground against the yen and European currencies, with the latter under pressure primarily due a surprisingly dovish release of the minutes from this week's Bank of England rate decision showing 1 vote calling for a rate cut against eight members voting for no change. Markets were pricing a 7-2 decision with the 2 members calling for a rate hike. Sterling reversed one cent of yesterday's rally, which was a result of surprisingly high CPI in February. The close of Japanese markets in observation of the Spring Equinox amplified Yen weakness into the European session, as risk appetite encouraged traders to take on fresh carry trades. Consequently, the dollar rise is accompanied by additional strengthening in gold, which hit a 2 1/2 week high at $660.80 per ounce.

What to look for in today's Fed statement

We look for the FOMC to keep rates unchanged at 5.25%, while toning down the upbeat language in the January statement regarding growth as well as dampening the optimism pertaining to the housing market. But this dovishness will be offset by maintaining an equally vigilant stance on inflation.

1. Toning down the growth outlook, consistent with February testimony

Recall that Fed Chairman Bernanke issued a less upbeat speech in last month's Congressional testimony, following a more optimistic January FOMC statement. Since the data have been markedly weaker since February, the Fed has no choice but to tone down the optimism in the phrase indicating "recent indicators have suggested somewhat firmer economic growth". With the evident decline in new home sales, jobless claims, manufacturing, jobless claims and payrolls (February was lowest in 13 months and 3-month average at 8-month lows), the Fed has no choice but to issue a less optimistic growth assessment.

2. Downgrade housing outlook

We expect the statement to downgrade the phrase stating "some tentative signs of stabilization have appeared in the housing market" to be modified towards a more apprehensive phrase in light of the closures of sub-prime lenders and recent tumble in new home sales.

3. But maintain inflation vigilance

Since Friday's release of the February headline CPI came out higher than expected at 0.4%, with the core CPI in line with expectations at 0.2%, we expect this week's FOMC statement to reiterate that "some inflation risks remain". Indeed, the year on year core CPI rose to 2.7% from 2.6% in January, which is a valid reason for the Fed to keep bullish bond traders on their toes.

Thus, any renewed dollar declines in reaction to Wednesday's FOMC statement will depend on the extent to which the statement will downgrade its growth assessment, including a less upbeat reference regarding the housing market following the deterioration of sub-prime lenders and sharp decline in new home sales.

USDJPY remains capped at 200-day MA

Continued yen weakness pushes the dollar to a session high of 117.83, but unlikely to breach above the 200-day moving average of 118 before this afternoon's Fed announcement (2:15 pm EST, 6:15 pm GMT). Despite a retreat in the Aussie following remarks from Australian Secretary addressing exporters' struggle with the currency appreciation, interest in the high yield carry trade does seem to re-emerge, boosting the AUD, GBP and USD. We continued to expect interim resistance at the 200-day MA of 118. The only event likely to push USDJPY above 118 prior to the Fed announcement would be additional buying in US stocks. In the event of a dovish Fed interpretation by the markets, we expect USD to make modest declines, towards 117.40 and 117. Support seen emerging at 116.80.

We expect the anticipated dollar impact from the downgrade of the growth phrase to dominate any persistence in the inflation reference.

A hawkish surprise (maintain phrase indicating additional firming) could boost USDJPY past the 118 figure to 118.55-60.

Euro gains dragged by BoE minutes

Euro's attempt to break out of the 1.3320 resistance was interrupted by sterling's retreat following the Bank of England's surprisingly dovish minutes. In line with yesterday's strategy piece, we expect EURUSD support above 1.3270. Should the Fed be perceived to have remained more upbeat than expected, EURUSD should extend losses past 1.3255-60, but support seen emerging at 1.3240 -- 38% retracement of the 1.3074-1.3341 move. Upside remains capped at 1.3320, but explicit Fed turn towards neutrality to trigger fresh bids towards the 1.3340 high and towards the 1.3370 all time high.

Dovish Fed is more likely to trigger upside play in EURGBP towards 67.30.

Cable rally knocked off by surprise dovish minutes

One day after sterling shot up to a 3 week high against the USD on an upside CPI surprise, the currency reversed 1/3 of those gains after this month's MPC minuets showed not only there were no members calling for a rate hike, but that one member -- David Blanchflower calling for a quarter point cut. Most in the market had expected a 7-2 vote, with the two newest members Tim Besley and Andrew Sentence once again demanding a rate hike. Interestingly, the minutes showed upside risk from wage growth to be diminishing, while stating that market volatility did support the case for rates to be kept steady.

The minutes may not yet rid of some pricing of a rate hike this year, but yesterday's upward bias in the pound may gradually recede, especially in the event of renewed unwinding of carry trades. In the short term, as long as markets expect an RBA rate hike, sterling may remain supported at 1.9550, backed by the 1.9530 trend line support. Key foundation stands at 1.95. Expect the pair to stabilize at 1.9620 until a FOMC dovishness triggers 1.9650 and 1.9670. Dovish Fed is more likely to trigger upside play in EURGBP towards 67.30.

The strong data were instrumental in Cable's breach above the 1.9530 trend-line resistance to 1.9577. US data weakness should fuel the pair towards the 1.96 figure, but resistance stands at 1.9630 -- 61.8% retracement of the 1.9914-1.9179 move. Key barrier stands at 1.9650. Cable downside risks seen from reemergence in sub-prime worries hitting carry trades. Support stands at 1.95.