The U.S. Dollar is Retreating Ahead of the ECB Meeting

The U.S. Dollar is showing slight weakness this week, as the U.S. Dollar Index (DXY) dropped by 0.2% to 103.07 points. The EURUSD also experienced a marginal decline of 0.1% to 1.08870. Taking a broader perspective, the pair has been rising from last week's lows at 1.08450, indicating a potential retreat of the Greenback.

The currency movements appear to be less grounded in fundamental logic. Traders are reassessing aggressive bets on interest rate cuts by both the Federal Reserve (Fed) and the European Central Bank (ECB). Bets on a Fed interest rate cut in March decreased to 42.4% from 73.0% the previous week, suggesting a more cautious approach with interest rates remaining at 5.50% until the May Fed meeting.

Despite these considerations, the Dollar has seen only a modest 0.4% rise since the strong U.S. labor market report for December. Larger investors seem hesitant to strongly bet on a rising Dollar, as evidenced by the capital inflows of $6.4 million into the WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) during the last two weeks, while net overall outflows were recorded at $24.0 million since the beginning of 2024.

The debt market has had a subdued reaction to these developments, with U.S. 10-year Treasuries yields increasing to 4.13% from 4.00%. Some major players may still be anticipating more aggressive rate cuts by the Fed.

Rumors about China's government moving around $278 billion to support the domestic stock market through offshore entities caused the Hang Seng index to rise by 2.6%. The Yuan also gained 0.4% against the Dollar, prompting the EURUSD to move up towards 1.09500-1.09700. However, these moves are likely to be influenced by the ECB meeting and the release of the Fed's preferred PCE index later in the week. The rhetoric from European central bankers and potential changes in expectations regarding interest rate cuts may impact currency movements. The EURUSD could find upside momentum if central bankers downplay the prospects of aggressive rate cuts. Analysts are expecting the PCE Index to remain at 2.6% YoY in December, with a slight increase in the monthly reading to 0.2% from -0.1% in November, presenting a relatively neutral outlook for the Dollar.