U.S. dollar modestly up as traders rebalance positions after sharp gains

The dollar was modestly higher on Friday in choppy trading after posting sharp gains the previous session, with investors digesting a raft of central bank rate hikes as they grappled with the prospect that borrowing costs still have a long way to climb.

"With most of 2022's biggest event risks out of the way, traders are rebalancing portfolios to harness expected shifts in monetary policy trajectories in the new year," said Karl Schamotta, chief market strategist at Corpay in Toronto.

"The Bank of Japan, European Central Bank - and even the Bank of England - are still seen making modestly-tighter adjustments in the coming months," he added.

The dollar briefly fell after data showed U.S. business activity shrank further in December as new orders slumped to their lowest in more than 2-1/2 years, while softening demand helped to significantly cool inflation.

S&P Global said on Friday its flash U.S. Composite PMI Output Index, which tracks the manufacturing and services sectors, fell to 44.6 this month from a final reading of 46.4 in November. It was the sixth straight month that the index remained below the 50 mark, which indicates contraction in the private sector.

In late morning trading, the greenback fell 0.8% against the yen to 136.74, after hitting a two-week high in the previous session.

The dollar turned higher against sterling, which was last down at $1.2176, while the euro slipped 0.1% to $1.0620.

On Thursday, the euro fell as well after the ECB raised interest rates and signalled it was far from finished, stirring fears about the potential damage to the global economy and sending investors towards the safe-haven greenback.

A day earlier, Fed Chair Jerome Powell said policymakers expected U.S. rates to rise further and stay elevated for longer.

New York Fed President John Williams upped the hawkish rhetoric on Friday, saying it remains possible the U.S. central bank raises interest rates more than it currently expects next year. The Fed has projected the peak fed funds rate at 5.1%.

That said, financial markets do not seem to be buying the hawkish Fed stance. The fed funds futures markets have priced in rate cuts by the end of 2023.

"Few expect the Federal Reserve to deliver on Wednesday's hawkishness," Corpay's Schamotta said.

The dollar index, which gauges the currency against six major peers, rose 0.1% to 104.58, after rallying more than 0.9% on Thursday.

The index has surged around 9% this year as the Fed has hiked interest rates hard, sucking money back towards dollar-denominated bonds. Yet it has dropped roughly 8% since hitting a 20-year high in September, as a slowdown in U.S. inflation has raised hopes the Fed's rate-hiking cycle might soon end, and better than expected economic data from Europe has boosted the euro.

The BOJ decides policy on Tuesday, and while no change is expected at that meeting, some market participants have begun betting on some tweaks to stimulus as Governor Haruhiko Kuroda prepares to depart in April.

The risk-sensitive Australian dollar was 0.1% lower at US$0.6694. The Aussie plunged 2.38% in the previous session - its biggest drop since March 2020. The New Zealand dollar rose 0.5% to US$0.6372.