The dollar strengthened on Tuesday ahead of an expected interest rate cut in the United States, as traders grew more confident that the Federal Reserve will gradually lower borrowing costs next year.

The euro, which is set to lose nearly 5% against the dollar this year, was trading at $1.04823 ahead of the Fed decision.

The gap between U.S. and German 10-year yields is 216 basis points, near its widest in five years, after rising nearly 70 basis points in three months, further weighing on the euro.

The Fed hands down its interest rate decision on Wednesday and interest rate futures imply a 94% chance of a cut, even as service sector activity surged to a three-year high, according to an S&P Global survey of purchasing managers.

The Atlanta Fed's GDPNow gauge was running at 3.3% for the fourth quarter, and the strength of the economy has lifted yields and supported the dollar as traders bet the neutral setting for interest rates may be higher than previously thought.

"We expect the Fed to show more caution over the path of future rate cuts. So 25 basis points is a done deal this week, but the big question is, of course, what happens next year," said MUFG currency strategist Lee Hardman.

"We think there is a higher probability that we will see the Fed skip its next meeting in January to keep rates on hold," he said.

U.S. President-elect Donald Trump took office in January. He has promised a series of actions to impose tariffs on imports from countries such as China, Canada and Mexico, as well as deport millions of undocumented migrants - both of which could contribute to a sustained rise in inflation and discourage the Fed from cutting rates further.

Source: Investing.com