The dollar pulled back from three-week highs on Wednesday as traders took some profits ahead of the Federal Reserve's first expected rate rise of 2018 and focused on whether the central bank will indicate three or four hikes for this year.

With the dollar down, the euro and yen were able to recover some losses made on Tuesday, when investors had piled into the greenback.

Elsewhere the Canadian dollar and Mexican peso both made gains after reports that the US administration had dropped a contentious demand related to auto-content, removing a key roadblock to a deal for a new North American Free-Trade Agreement (NAFTA).

The dollar fell 0.2 per cent against a basket of currencies, after hitting a nearly three-week high on Tuesday.

The US currency has been stuck in a trading range as investors wait for clarity on whether the policy-setting Federal Open Market Committee (FOMC) will forecast four rate hikes this year, instead of the median three hikes seen in December's quarterly forecast.

Following the FOMC announcement at 1800 GMT, Jerome Powell will hold his first news conference as Fed chief at 1830 GMT.

Many analysts are questioning whether the dollar can rally much on the back of a more hawkish tone from the Federal Reserve, given so many investors still hold a bearish view.

The dollar sold off heavily at the start of the year on bets that trade and budget deficits would weigh on it, aided by comments by the US Treasury Secretary that his government welcomed a weaker dollar.

“This FOMC will have to go some to really move the needle on market thinking or indeed, to take the dollar out of its current range and the FX market out of its mindset,” said Kit Juckes, chief FX Strategist at Societe Generale.

The two-year yield jumped to a near 9-1/2-year high of 2.3324 per cent on Tuesday.

As the US currency fell, the euro firmed 0.4 per cent to $1.2282, having fallen 0.78 per cent on Tuesday and hitting a near three-week low of $1.2240.

Against the yen, the dollar fell 0.2 per cent to 106.31 yen , after Tuesday's gains of 0.41 per cent, though trading was slow due to a public holiday in Tokyo.

Focus on tariffs

The Australian dollar hit a three-month low of $0.7679 on Tuesday but recovered some ground on Wednesday to trade up 0.2 per cent at $0.7695.

Australia, a big producer of basic commodities, is among the most vulnerable economies should US protectionism lead to a tit-for-tat reprisal from China, a key consumer of several commodities.

The Canadian dollar gained 0.2 per cent to C$1.3041 to the US dollar, while the Mexican peso gained 0.7 per cent to 18.630 per U.S. dollar, following the report of softening in Washington's stance towards the NAFTA.

“Currently there is still a lot of uncertainty on how Trump will negotiate new terms for NAFTA, but signs are looking good after he has come down significantly from his 'no NAFTA' rhetoric when he first took over as the 45th POTUS,” said Mingze Wu, FX trader of global payments for INTL FCStone Ltd in Singapore.

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