The outcome of Wednesday’s Federal Reserve meeting is expected to set the tone for trade in the U.S. dollar heading into 2014, whatever decision is reached on the highly-anticipated tapering of monetary stimulus.
Contrary to expectations, the dollar has not seen a broad-based surge even as market expectations for when Fed tapering will begin have been bought forward in the face of upbeat economic data.
While the dollar hit a five-year high against the yen last week, it has weakened almost 8 percent against the euro in the past three months. The dollar index, which measures the greenback’s value against a basket of other major currencies, is hovering around 80.04 – not far from where it ended last year.
“All the pundits have said we’re going to have tapering, the dollar is going to go through the roof and so forth,” said Axel Merk, president and CIO at Merk Investments. “Guess what, the dollar has weakened against the euro for example and the reason is that the dollar is not benefiting from this [tapering expectations] and won’t benefit next year because the Fed is behind the curve.”
(Read more: Fed taper expected sooner: CNBC Survey)
The Fed took markets by surprise in September by not starting a widely-expected scaling back of its $85 billion-a-month asset purchase program.
A CNBC Wall Street survey this week showed that expectations are for Fed tapering to begin in February, two months earlier than expected in an October survey. Recent stronger-than-expected economic data, including the November payrolls report, have fueled talk that the Fed could taper at the end of the two-day meeting on Wednesday.
(Read more: Bernanke should lay groundwork for QE pullback)
“When we look at where expectations are, about 30 percent of the market expects Wednesday to be the beginning of the taper. That puts 60-70 percent of the market still in January or March, so there are going to be some investors that are surprised one way or another,” Richard Cochinos, head of Americas G10 currency strategy at Citi, told CNBC Asia’s “Squawk Box.”
“So from a dollar perspective, we are still bullish. When we look at positioning, real money is relatively short the dollar, they’re long carry, they’re long emerging FX. We think there’s going to be some re-balancing of portfolios after the Fed,” he added.
US dollar index this year
Analysts said that even if the Fed decides to keep policy unchanged on Wednesday, a failure to send a hawkish message would be negative for the greenback.
“If the central bank fails to be as hawkish as the market expects, profit-taking on [long dollar] positions could drive the dollar quickly and aggressively lower even if the Fed ends up being one of the few central banks unwinding stimulus next year,” said Kathy Lien, managing director at BK Asset Management, in a note.
“The worst outcome for the dollar would be if the Fed says no to tapering and forward guidance,” she added.
— By CNBC.Com’s Dhara Ranasinghe