SINGAPORE, Jan 29 (Reuters) - The dollar started the week on a steady footing as investors took stock of U.S. economic data ahead of the Federal Reserve policy meeting this week, while escalating geopolitical tensions in the Middle East kept a lid on risk sentiment.
The dollar index, which measures the U.S. currency against six rivals, was little changed at 103.50 on Monday and remained close to the six-week high of 103.82 it touched last week. The index is set for a 2% gain in January as traders temper expectations of early and deep U.S. interest rate cuts.
The Fed in December surprised markets by taking a dovish tilt and projecting 75 basis points of rate cuts in 2024, resulting in traders pricing in aggressive easing, with a cut expected as early as March.
But since then, strong economic data and pushback from central bankers have prompted traders to adjust expectations. Markets are currently pricing in a 48% chance of a rate cut in March, the CME FedWatch tool showed, compared with an 86% chance at the end of December.
"The markets recognise that tightening cycle is over. However, they swung hard, pricing in aggressive easing by most of the G10 central banks," said Marc Chandler, chief market strategist, at Bannockburn Forex.
The coming weeks will likely continue the correction of the trends that began last month, Chandler said.
Data on Friday showed U.S. prices rose moderately in December, keeping the annual increase in inflation below 3% for a third straight month and reinforcing expectations that rate cuts are likely to come this year.
Investor attention this week will squarely be on the Federal Reserve's two-day policy meeting which starts on Tuesday, with the central bank widely expected to stand pat on rates, leaving the spotlight all on Fed Chair Jerome Powell and his comments.
Beyond the Fed, investors will also watch for a slew of economic data including a U.S. jobless data and payrolls report that will help gauge the strength of labour market.
The euro was down 0.08% at $1.0842, and is headed for a 2% decline in the month. The European Central Bank last week held interest rates at a record-high 4% and reaffirmed its commitment to fighting inflation.
Traders though are piling on bets that the ECB will cut interest rates from April, with nearly 140 basis points of easing priced in for the year.
Sterling last bought $1.2704, up 0.01% on the day ahead of the Bank of England's policy meeting later this week.
The Japanese yen strengthened just a tad to 148.07 per dollar, but is on course for a 5% decline in January, its weakest monthly performance since June 2022, as traders temper their expectations of when the Bank of Japan would exit from its ultra-loose policy.
"Towards the end of December we saw positioning become net long JPY – perhaps fueled by expectations for both, aggressive Fed easing, as well as rapid BOJ policy normalization," said Sid Mathur, head of Asia macro strategy and emerging market research at BNP Paribas.
"But both those expectations have been scaled back over the past couple of weeks, and the BNPP positioning indicator suggests that those JPY longs have also been reduced."
On the geopolitical front, investors are also wary of growing risks after three U.S. service members were killed in an aerial drone attack on U.S. forces in northeastern Jordan near the Syrian border.
U.S. President Joe Biden blamed Iran-backed groups for the attack, the first deadly strike against U.S. forces since the Israel-Hamas war erupted in October.
The geopolitical ructions could provide the safehaven yen a temporary lift, analysts said.
Elsewhere, The Australian dollar rose 0.29% to $0.6591, while the New Zealand dollar gained 0.12% to$0.60975.
In cryptocurrencies, bitcoin last rose 0.55% to $42,2016.
(Reporting by Ankur Banerjee in Singapore; Editing by Sam Holmes and Shri Navaratnam)
