The dollar inched up in quiet trade on Wednesday in anticipation that the Federal Reserve will leave the door open for more interest rate increases after a widely expected hike at the end of its meeting on Thursday.
However, some dealers thought the market was overreaching and were expecting the dollar to give up ground after a rise in the benchmark federal funds rate to 5.25 percent from 5 percent anticipated at the end of Fed policy talks now under way.
"There seemed to be some decent-sized buyers out there that pushed through a couple of levels and got things moving," said John Beerling, chief dealer with Wells Fargo in Minneapolis.
"But all the possible good news has been priced in and there seems to be only a chance for disappointment," he added. In late afternoon trading, the euro was down 0.25 percent against the dollar at $1.2551.
"I think a lot of the guys have been buying (euros) above $1.26 and stops have been triggered in the last few days," said Rafael Martorell, chief dealer at BNP Paribas in New York. "I think they are reversing that ahead of the Fed tomorrow."
The euro has been stuck in a range of roughly $1.25 to $1.27 for three weeks so is now near the bottom of that range. J.P. Morgan analysts said that according to the bank's proprietary data, speculative investors had amassed a long euro/dollar position at 1.4 times the average of the last 12 months.
Market positioning by speculators is often used by analysts as an indicator of market direction. For instance, extreme net long positions can suggest a currency has already appreciated a great deal and is poised for a correction lower as dealers attempt to lock in profits.
However, it is very likely the upcoming Federal Open Market Committee policy statement, not positioning, will govern the near-term direction for the dollar.
Interest rate futures markets on Wednesday priced in more than an 80 percent chance that the fed funds rate would rise to 5.5 percent at the August Fed meeting. A quarter-point rate increase this week is fully priced in.
The sentence in May said "further policy firming may yet be needed", suggesting strong economic data would be needed for the US central bank to continue tightening monetary policy after what is expected to be the 17th straight rate increase.
"Leaving this phrase (unchanged) should sustain expectations for a tightening at the subsequent meeting on August 8, while leaving the FOMC with the flexibility not to do so," said David Sloan, economist with 4CAST in New York.
Such vagueness could be enough to incite a sell-off in the dollar, analysts said.
The dollar was up 0.2 percent at 116.43 yen, after rising to a two-month high on Tuesday around 116.70. Against the Swiss franc, it rose 0.3 percent to 1.2460 francs, while sterling fell 0.2 percent to $1.8178.