Extended Fed pause hopes boost dollar

NEW YORK (CNNMoney.com) -- After taking a beating last year, the dollar has steadied its course and could be poised for a lift as expectations for the Federal Reserve to cut rates fall by the wayside.

The weak greenback triggered a fresh round of worries in November when it fell sharply against the euro over a handful of sessions. For the year, the dollar skidded 11 percent versus the eurozone currency.

But since then, the dollar has steadied. It's up nearly 2 percent versus the euro so far in 2007 and is near a four-year high against the Japanese yen.

Helping ease the pressure has been a growing belief that the economy has avoided a recession and that the Fed won't have to cut rates to stimulate growth. That would boost the dollar because the market is still pricing in at least a 25 to 50 basis point cut, analysts said.

"We've slowly but surely changed our view about imminent rate cuts, and we're now expecting the Fed to be on a continued pause," said Brian Wesbury, chief economist at First Trust Advisors.

The Fed has held the target for a key short-term interest rate steady at its last four meetings. Central bank policymakers will hold their first meeting of the year next Tuesday and Wednesday.

Since the middle of last year, the focus of the markets has been whether the Fed will be tempted to lower interest rates to stimulate the economy, said Kathy Lien, chief currency strategist at Forex Capital Markets.

Lower rates in the U.S. make the dollar less attractive relative to other currencies, and a weak dollar makes traveling abroad and buying foreign products more expensive for Americans.

But "the latest round of U.S. data has been very positive and basically suggests the pace of the 'Goldilocks' economy can continue," Lien said, referring to an economy that many believe is not too hot and not too cold.

Job growth has been solid. The latest payrolls report came in well above forecasts, and concerns about a retreat in manufacturing were soothed after the Institute of Supply Management's index showed growth in December.

Another boost for the economy: tumbling oil prices, which fell below $50 a barrel earlier this month and now are trading about 30 percent below their record high.

If oil prices remain in the mid-$50 to $60 range, then they would play an important role in facilitating a so-called soft landing for the economy, which would be instrumental in preventing the Fed from having to cut rates, said Ashraf Laidi, chief analyst at CMC Markets.

But any gains the dollar makes are likely to be limited, analysts said, and for the long-term, the dollar remains on a downward trajectory.

For one, foreign central banks unwilling to keep financing the U.S.'s ballooning current account deficit will keep diversifying their reserves.

"Central banks will find any intermittent bouts of dollar strength as a pretext to sell dollars at highs and buy euros at the dips," Laidi said.

Furthermore, rates are all but certain to rise overseas, particularly in Japan, as economic growth accelerates there.

"Rough roads remain ahead for the greenback, as interest rate spreads tighten throughout the globe," Douglas Porter, deputy chief economist at BMO Capital Markets, wrote in a recent report. "However, the US dollar fall should be gradual and orderly, as the currency will bend but not break," he wrote.

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