The U.S. dollar has strengthened and Treasury bond prices have dropped so far in May but testimony from Federal Reserve Chairman Ben Bernanke on Wednesday could set the tone for the rest of the month.

Investors will also get the minutes from the last Fed meeting on Wednesday, so PowerShares DB US Dollar Index Bullish Fund (NYSEArca: UUP) and iShares 20+ Year Treasury Bond Fund (NYSEArca: TLT) could see action.

The dollar ETF has been climbing in May amid speculation the Fed could soon signal it will taper its bond purchases designed to keep interest rates low and stimulate the economy. Also, Bernanke recently warned about the risks of stretching for yield.

However, St. Louis Fed President James Bullard on Tuesday said there is no case yet for tapering until inflation picks up, reports. “Inflation is pretty low in the U.S.,” Bullard said. “I can’t envision a good case to be made for tapering unless the inflation situation turns around.”

Also Tuesday, Federal Reserve Bank of New York President William Dudley said he’s not sure whether the Fed should boost or shrink its bond purchases due to the uncertain outlook for the economy, according to Bloomberg News.

David Kelly, chief global strategist at JP Morgan Funds, in a note this week said there is little evidence yet that the Fed is veering from its current course on quantitative easing.

“However, Bernanke and other members of the FOMC have expressed uneasiness about the potential for continued QE to contribute to bubbles in parts of financial markets and the recently surging U.S. equity market may be adding to their discomfort.  The Fed must also be considering the growing potential for rebounding housing and stock market wealth to support the U.S. economy making extreme monetary ease less appropriate,” Kelly wrote.

“Finally, improved budget numbers, while emphasizing the degree of fiscal drag on the economy right now, also make the current QE program look more excessive as the Fed’s demand for new bonds (both Treasuries and mortgages) exceeds the entire net supply of bonds from the Treasury department,” the strategist added. “While Bernanke will, as usual, choose his words carefully, there is clearly a risk that something he says or some language in the Fed minutes could cause long-term interest rates to move higher.”

PowerShares DB US Dollar Index Bullish Fund

Full disclosure: Tom Lydon’s clients own TLT.

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