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Dollar Higher Ahead of Fed, But Likely to Resume Downtrend, Experts Say

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By Yasin Ebrahim

Investing.com – The dollar inched higher on Monday, ahead of the Federal Reserve's two-day meeting, which kicks off on Tuesday and is expected to result in an unchanged decision on monetary policy.

The U.S. dollar index, which measures the greenback against a trade-weighted basket of six major currencies, rose by 0.14% to $90.38.

The Federal Open Market Committee's two-day meeting is expected to culminate in a decision to keep rates on hold within the 0% to 0.25%. The pace of monthly bond purchases is expected to be maintained at monthly pace of $120 billion.

With the Fed widely expected to stand pat on monetary policy, investor attention will focus on the tone from the central bank concerning its economic outlook.

The economic recovery has come under pressure recently from rising infections that have forced further lockdowns but the outlook appears more sanguine over the medium-to longer-term that may likely encourage the Federal Reserve to tightened policy sooner than expected.

"If we are right and we see a period of booming growth, elevated inflation and ongoing fiscal stimulus the Fed may feel compelled to act somewhat sooner than they are currently indicating," ING said in a note. "We could conceivably see the Fed start to taper at the end of this year with a rate hike likely to be on the agenda for 2023."

In December, FOMC members indicated that the Fed would likely remain on hold through 2023.

Expectations for tightening of Fed policy alongside growing bets for a pick-up in inflation have helped boost U.S. Treasury yields. But the traditional boost to the dollar from a steepening U.S. rate curve – longer-term rates rising faster than shorter-term rates – is unlikely to occur as falling short-term rates contributes to "lower currency hedging costs for foreigners wishing to neutralize the dollar risk of their U.S. Treasury purchases," Wells Fargo (NYSE:WFC) said.

"Lower yields and flatter curves abroad is one reason we expect further rises in U.S. rates to be moderate, but a steeper U.S. curve also means cheap currency hedges for foreign investors. We believe this should keep downward pressure on the dollar."

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