Dollar set for fourth monthly drop as Fed meeting looms

The dollar was eyeing a fourth monthly loss on Tuesday as investors reckon a peak in US interest rates could swing into view as soon as this week's Federal Reserve meeting.

Currency trade was subdued in the lead up to Wednesday's Fed rate decision, and ahead of Bank of England and European Central Bank rate decisions on Thursday, though cautiousness across financial markets lifted the greenback a little bit overnight.

The euro rose as far as $1.0913 after data showed Spanish inflation running surprisingly hot in January, before the broader mood reeled it back to $1.0851. The common currency is up 1.3% this month and is loitering near a nine-month peak.

The US dollar index is down 1.3% for January so far, though it rose 0.3% to 102.19 overnight. The Japanese yen fell 0.4% overnight but is set for its third monthly gain as markets anticipate shifts in monetary policy.

Sterling and the Australian, New Zealand and Canadian dollars also made overnight losses but are set for monthly gains.

The Aussie fell 0.7% overnight, but at $0.7060 it is up about 3.6% for the month so far. The kiwi, last at $0.6474, is up almost 2% for January. 

"Technically I think they're looking a little bit tired," said Tony Sycamore, an analyst at brokerage IG Markets in Sydney, referring to currencies rallying against the dollar, with investor caution and month-end dollar buying also contributing to Monday's moves.

Interest-rate futures indicate market expectations for a 25 basis point (bp) hike from the Federal Reserve to take the Fed funds rate window to 4.5%-4.75%. Pricing suggests two more 25 bp hikes are expected, before cuts arrive later in the year.

"Traders will need to marry the tone of the statement and (Fed chair Jerome) Powell's press conference with this pricing structure," said Chris Weston, head of research at broker Pepperstone in Melbourne.

"In the less likely outcome that the Fed give the impression that they could pause after this week's hike, then the US dollar could easily sell off and risky assets rally."

Ahead of the Fed, traders await Chinese manufacturing data and Australian retail sales figures later on Tuesday, as well as a preliminary reading for euro zone gross domestic product.

US employment cost data will also be closely watched because the labour market can guide monetary policy.

"It is probably too late to have too much influence on the ultimate size of the widely expected 25bp rate hike that is due to be announced on Wednesday," said NatWest Markets' US rates strategist Jan Nevruzi. "But results from the report will play a big role in the tone Powell uses in his press conference."