The US Dollar took a step back to start the week as investors turned their attention to the Federal Reserve’s upcoming rate decision on Wednesday. Market sentiment remains cautiously optimistic as traders widely anticipate a third consecutive 25-basis-point rate cut from the Fed.

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US Dollar Index Pauses Ahead of Fed Meeting

The US Dollar Index (DXY) edged 0.16% lower on Monday, trimming recent gains and stalling at the peak of its near-term bullish momentum. Markets are in wait-and-see mode as the Fed’s interest rate decision looms large. According to the CME FedWatch Tool, there is a 99.1% probability of a 25-basis-point rate cut, which has already been priced into the market.

What’s more critical for investors will be the Fed’s Summary of Economic Projections (SEP)—the closely watched “dot plot” that provides insights into policymakers’ future interest rate expectations. Traders are eager to see whether the Fed will signal further cuts in the months ahead or adopt a more cautious stance.

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US Economic Data: PMI Paints a Mixed Picture

Monday’s Purchasing Managers Index (PMI) figures delivered mixed results for December:

• Services PMI surged to multi-year highs, reflecting strength in the service sector.
• Manufacturing PMI, however, fell sharply, missing expectations and sinking further into contractionary territory below the 50.0 threshold.

The mixed data underscores the uneven nature of the US economic recovery. Looking ahead, US Retail Sales data, due on Tuesday, will offer additional clues about consumer spending. However, its market impact may be limited as investors focus squarely on the Fed’s last rate call of the year.

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EUR/USD Holds Steady Amid European PMI Beat

The EUR/USD pair traded in familiar territory near 1.0500 as the euro failed to gain significant momentum despite a flurry of European Central Bank (ECB) official speeches.

December’s European PMI data broadly exceeded expectations, offering some hope for the region. However, the underlying picture remains shaky:

• Services PMI remains stuck in contraction territory, highlighting ongoing concerns about a deeper economic slowdown in Europe.

Investor sentiment toward the euro remains cautious as recessionary fears continue to weigh on businesses across the continent.

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GBP/USD Rebounds as Manufacturing Surprises

The GBP/USD pair broke its three-day losing streak on Monday, rising 0.55% and pushing back above the 1.2700 mark. While UK Services PMI data disappointed, falling to an 11-month low, a surprise uptick in the Manufacturing PMI helped buoy the pound.

Looking ahead, all eyes are on Tuesday’s UK labor market data, particularly Average Earnings, which are expected to accelerate to 5% year-over-year. Strong wage growth could reinforce inflationary pressures and keep the Bank of England on its toes as it navigates monetary policy in 2024.

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USD/JPY Climbs Ahead of BoJ Decision

The USD/JPY pair regained ground on Monday, climbing just under 0.3% to move back above the 154.00 level. With limited economic data from Japan this week, investor focus is firmly on the Bank of Japan’s (BoJ) policy decision on Thursday.

The BoJ is widely expected to keep rates unchanged in December, but investors will be looking for clues about what conditions might prompt the central bank to tighten monetary policy further in the future.

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The Bottom Line

As the trading week progresses, the Federal Reserve’s rate decision and economic projections will dominate market sentiment. While a 25-basis-point rate cut appears all but certain, traders will parse the Fed’s language for signals about future rate moves. In the meantime, economic data releases, including US Retail Sales and UK labor figures, will provide important context for currency movements across the board.

Markets remain cautiously optimistic, but with central bank decisions on the horizon, volatility could quickly return to the forefront.