Investing.com – The U.S. dollar softened in early Tuesday trading as investors treaded cautiously ahead of the highly anticipated Federal Reserve meeting. Meanwhile, the euro strengthened, boosted by optimism surrounding Germany's proposed multibillion-euro stimulus plan, which could soon clear a major parliamentary hurdle.

Dollar Dips as Markets Await Fed's Economic Outlook

As of 05:00 ET (09:00 GMT), the U.S. Dollar Index (DXY)—which measures the greenback’s performance against a basket of six major currencies—dipped 0.1% to 102.89. Despite the decline, the index remained just above last week’s five-month low of 102.35.

Investor sentiment toward the dollar has been fragile in recent sessions, weighed down by uncertainty over the Federal Reserve’s next move and growing concerns about the broader economic outlook in the wake of lingering trade tensions and inflation worries.

Retail Sales Show Tepid Growth

Fresh data released Monday indicated that U.S. retail sales rose 0.2% in February, rebounding modestly after a sharp 1.2% decline in January. While the uptick signals continued consumer spending, the figure missed economists’ forecast for a 0.6% gain, hinting at slower momentum in Q1 economic growth.

"These numbers are a mixed bag," said James Knightley, Chief International Economist at ING. "While consumer resilience is evident, it’s not quite the strong rebound markets were hoping for."

Focus Shifts to the Federal Reserve’s Two-Day Policy Meeting

All eyes are now on the Federal Reserve's two-day policy meeting, which kicks off Tuesday and concludes Wednesday afternoon. Market consensus strongly suggests the Fed will hold interest rates steady at 5.25%-5.50%. However, traders are more interested in the Fed’s updated Summary of Economic Projections (SEP), which will shed light on policymakers’ views regarding inflation, GDP growth, and the future rate path.

Analysts at ING wrote, "The Fed may strike a cautious tone given persistent inflationary pressures. We don’t expect the FOMC to provide much relief for risk appetite just yet."

According to the CME FedWatch Tool, markets are pricing in a roughly 55% chance of a rate cut by June 2025, but sticky inflation could delay that timeline.

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Euro Strengthens Ahead of German Stimulus Vote

Over in Europe, the EUR/USD pair gained 0.3% to trade at 1.0951, hovering near its highest level since October 2023. The euro’s momentum is underpinned by optimism that Germany’s Bundestag will soon pass a landmark fiscal stimulus package aimed at rejuvenating Europe’s largest economy.

Germany's €200 Billion Stimulus in the Spotlight

Germany's proposed stimulus plan includes over €200 billion ($217 billion) in public borrowing to fund infrastructure development, green energy initiatives, and support for struggling businesses amid a sluggish post-pandemic recovery.

On Monday, Germany’s constitutional court dismissed legal challenges from opposition lawmakers seeking to block the plan. This ruling paves the way for the government’s coalition partners to push through the spending package.

"Passage of this stimulus bill could be a game-changer for the eurozone," said Ulrich Leuchtmann, Head of FX at Commerzbank. "A fiscal boost of this magnitude would ease recession fears and could lead to further euro gains."

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Pound Edges Higher as Traders Eye Bank of England

The GBP/USD pair inched 0.1% higher to 1.3001, reclaiming the key psychological level of 1.30 for the first time since November 2023. The British pound has found support as markets brace for the Bank of England's (BoE) policy decision due Thursday.

The BoE is widely expected to hold interest rates steady at 5.25% amid signs that inflation edged up to 4.2% in February from 4.0% in January. However, any surprise hawkish tilt from policymakers could push sterling even higher.

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Yen Slips Ahead of Bank of Japan Meeting

In Asia, the USD/JPY pair climbed 0.3% to 149.70, as traders anticipate the Bank of Japan’s (BoJ) latest policy announcement on Wednesday. The BoJ is expected to maintain its ultra-loose monetary policy, leaving its benchmark interest rate unchanged at 0.5%, despite mounting inflationary pressures and the weakest yen in over three decades.

Speculation is growing that the BoJ may soon signal a shift toward policy normalization. Analysts at Nomura predict the central bank could end negative interest rates by mid-2025 if inflation remains above target.

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Chinese Yuan Steady as Beijing Rolls Out Domestic Consumption Drive

Elsewhere, the Chinese yuan held firm against the dollar. The USD/CNY pair slipped 0.1% to 7.2234 after the Chinese government unveiled a comprehensive "special action plan" aimed at boosting domestic consumption. The plan includes incentives for consumers to purchase electric vehicles, home appliances, and services, as well as support for small and medium-sized enterprises (SMEs).

The policy push comes as China grapples with a real estate slowdown and sluggish exports, with Beijing aiming to achieve its 5% GDP growth target for 2025.

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Geopolitical Factors in Play: Trump-Putin Call Raises Eyebrows

Adding to market unease is the potential fallout from an upcoming call between U.S. President Donald Trump and Russian President Vladimir Putin. Investors are watching closely for any signs of a ceasefire in Ukraine or changes in sanctions policy, which could have broad implications for energy markets and risk sentiment.

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Bottom Line

The currency markets are treading cautiously ahead of major central bank decisions and key geopolitical developments. While the U.S. dollar faces headwinds from an uncertain Fed outlook, the euro and pound are benefiting from regional policy momentum.

Stay tuned as the Fed’s economic projections on Wednesday, along with votes on Germany’s stimulus package and the BoE’s rate decision, will likely set the tone for global forex markets in the days ahead.

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