The dollar held firm on Tuesday, with traders increasingly convinced that the Federal Reserve will only lower interest rates gradually next year. The euro, which is on track to fall nearly 5% against the dollar this year, traded at $1.04823 ahead of the Fed’s interest rate decision on Wednesday.
The gap between U.S. and German 10-year yields is near its widest in five years, with the difference increasing by nearly 70 basis points in three months, weighing on the euro. Interest rate futures imply a 94% chance of a cut, despite services-sector activity leaping to a three-year high, according to an S&P Global purchasing managers survey.
economist Lee Hardman said, “We’re looking for the Fed to indicate more caution over the future path of rate cuts. So 25 basis points is a done deal this week, but the key question is, obviously, what happens next year.” He expects the Fed to skip the next meeting in January to leave rates on hold.
U.S. President-elect Donald Trump’s plans, including imposing tariffs on imports and deporting millions of undocumented migrants, could contribute to sustained inflation and prevent the Fed from cutting rates more deeply.
The dollar’s strength has been supported by the economy’s growth, with the Atlanta Fed’s GDPNow indicator running at 3.3% for the fourth quarter. Market pricing implies almost no chance of rates being as low as 2.9% by December 2025 and only a 30% chance of the Fed Funds rate falling below 3.75% by the end of 2025.