The US dollar held its ground on Monday as investors cautiously digested recent economic data ahead of the crucial Federal Reserve meeting this week. Geopolitical tensions in the Middle East further dampened risk appetite, keeping traders on edge.

The dollar index, tracking the greenback against six major rivals, inched slightly higher to 103.53, lingering near its six-week peak touched last week. Despite some minor fluctuations, it's poised for a 2% monthly gain in January, reflecting a shift in market expectations away from aggressive US interest rate cuts.

December's dovish surprise from the Fed initially fueled speculation of rapid easing, with traders anticipating a rate cut as early as March. However, robust economic data and hawkish remarks from central bankers have since cast doubt on such a swift pivot. Currently, markets place a 49% probability on a March rate cut, a significant drop from 86% at the year's end.

"Interest rate expectations remain the primary driver of financial markets," noted Lloyds Bank economist Nikesh Sawjani. "The Fed's current dilemma lies in balancing unexpectedly resilient economic activity with ongoing, albeit decelerating, inflation. This hardly screams urgent rate cuts."

Friday's data confirmed a moderate rise in US prices for December, marking the third consecutive month with inflation below 3%. All eyes now turn to Wednesday's Fed announcement, with Chair Jerome Powell's comments carrying significant weight.

"We don't anticipate an immediate rush to rate cuts, likely keeping the USD broadly firm," predicted Roberto Mialich, global FX strategist at UniCredit Bank.

Meanwhile, the euro dipped 0.1% to $1.0838, on track for a near 2% monthly decline. While the European Central Bank maintained its record-high 4% interest rate last week, reiterating its commitment to inflation control, traders are heavily betting on rate cuts starting in April. Nearly 140 basis points of easing are priced in for the year, further fueled by comments from ECB Vice-President Luis de Guindos emphasizing the eventual need for rate cuts in light of recent eurozone inflation trends.

Sterling remained flat at $1.2703 ahead of the Bank of England's policy decision on Thursday.

The Japanese yen gained some ground, trading at 147.865 per dollar, but remains on course for its worst monthly performance since June 2022, down nearly 5%. This reflects fading expectations of the Bank of Japan abandoning its ultra-loose monetary policy.

"Aggressive Fed easing and rapid BOJ policy normalization hopes were driving JPY long positions towards December's end," explained Sid Mathur, head of Asia macro strategy at BNP Paribas. "With both scenarios losing steam, those JPY longs have significantly receded."

Adding to the market jitters, the aerial drone attack on US forces in Jordan heightened geopolitical concerns. Analysts anticipate this could temporarily boost the safe-haven yen.

In conclusion, the financial markets are navigating a delicate balance between economic data, central bank decisions, and geopolitical uncertainties. While the dollar retains its strength on tempered Fed easing expectations, the euro faces downward pressure amid ECB easing bets. The coming days promise further volatility as key central bank meetings and evolving geopolitical situations capture investor attention.