FOREX-US dollar retreats amid overall caution ahead of Fed decision

By Stefano Rebaudo and Gertrude Chavez-Dreyfuss

MILAN/NEW YORK, Dec 10 (Reuters) - The U.S. dollar weakened on Wednesday, erasing two days of gains, as investors trimmed positions in anticipation of an expected third consecutive interest rate cut of a quarter of a percentage point by the Federal Reserve.

Investors expect the policy-setting Federal Open Market Committee, including Chair Jerome Powell, to stay non-committal on further easing , citing persistent inflation risks and a lack of new and more relevant data to gauge the U.S. economy’s current health.

"The Fed has no other choice but to do a hawkish cut, which is what everybody's expecting. We certainly had plenty of economic data - not the primary data though - that suggests the job market has slowed, that prices have stabilized and you're not getting massive inflation," said Eugene Epstein, head of trading and structured products at Moneycorp in New Jersey.

"But the most recent data that everybody looks at - nonfarm payrolls, CPI, etc - have not been released yet. So the Fed is running semi-blind at this meeting because they don't have the full picture just yet on the economy."

Investors overall have pared expectations of rate cuts in 2026. U.S. rate futures have priced in just two more rate cuts in 2026 that brings the Fed policy rate to 3.0%. That's still lower, however, than the Fed's rate forecast of 3.4% spelled out in its so-called "dot plot".

Market participants continued to price out U.S. recession risk given the recent run of data that showed the economy, while exhibiting pockets of weakness in the labor and manufacturing sectors, is not necessarily falling off a cliff.

Data on Tuesday showed U.S. job openings increased marginally in October after surging in September, suggesting the labor market is cooling.

White House economic adviser Kevin Hassett, the front-runner to be the Federal Reserve's next chair, told the WSJ CEO Council on Tuesday there was "plenty of room" to cut interest rates further, though he added that if inflation rose the calculation might change.

In late morning trading, the dollar fell 0.3% against the yen to 156.45 yen JPY=EBS, while the dollar index slid 0.2% to 99.067 =USD.

EURO SUPPORTED BY THE RATE OUTLOOK

The euro rose 0.1% to $1.1643 EUR=EBS as investors focused on its gap with U.S. bond yields and saw little chance of a significant drop in euro zone rates in the near term.

Strong economic data and comments from European Central Bank policymaker Isabel Schnabel - who said a rate hike was more likely than a cut - led investors on Monday to rule out a rate cut in 2026 and assign more than a 50% chance of a hike in March 2027.

"ECB's Schnabel validated the hawkish expectations of the market on increased adoption of AI technologies and public investments pushing the neutral rate higher," said Andrea Appeddu, strategist at Citi.

ECB President Christine Lagarde said on Wednesday the ECB might lift its growth projections again in December given the economy's unexpected resilience to uncertainty and trade tensions.

Market players also monitored developments in Ukraine, while the European Union neared a deal to fund Kyiv in 2026 and 2027 that would win backing from at least a qualified majority of member states.

In other currency pairs, the Japanese currency sank to a record low =EBS> against the euro at 182.59 yen. The euro was last down 0.1% at 182.85.

“The yen should find sufficient support ahead of the upcoming BoJ decision, but its policy space will be shaped as much by domestic politics and fiscal aspects as by global (rate) differentials,” said Geoff Yu, EMEA macro strategist at BNY.

The Bank of Japan meets next week and is expected to raise interest rates. The market will also follow closely what Governor Kazuo Ueda says about the future policy path.

Canada's central bank held its key policy rate steady at 2.25% on Wednesday as widely expected, and Governor Tiff Macklem said the economy was proving resilient overall to the effect of U.S. trade measures.

The U.S. dollar edged higher against the Canadian currency, rising 0.1% to C$1.3864 CAD=D3.