Dollar hits two-week high, Middle East conflict and rate paths in focus

On September 2, the U.S. dollar reached a two-week high, as investors turned to the greenback amid growing concerns over the economic fallout from the energy crisis. Tensions escalated between Iran and its Arab neighbors, reigniting conflict after weeks of heightened hostilities. The dollar typically gains value when oil prices rise, as the U.S. economy is less vulnerable to energy shocks compared to other major economies, driving demand and benefiting from the U.S. dollar.

While most analysts forecast the European Central Bank will conclude its rate hikes by the end of the year, the Federal Reserve is grappling with the possibility of initiating policy tightening as early as 2027. George Brown, a senior economist at Schroders, noted that this disparity in monetary policy could strengthen the dollar and weaken the euro.

Schroders anticipates the euro falling to $1.10 against the dollar by the end of the year. However, a decline in U.S. Treasury prices due to worries about inflation and fiscal policy could undermine the dollar's strength, as mounting debt levels and persistent price pressures raise doubts about the long-term viability of U.S. assets.

The dollar index, which gauges the greenback's performance against a basket of currencies, climbed to 99.865, its highest level since August 17, while the euro slipped 0.16% to $1.1575. The yield on the benchmark U.S. 10-year note surged to 4.8182%, the highest since November 2023. Markets are forecasting a 68% probability of a September Federal Reserve rate increase, up from roughly 40% a week prior, according to CME Group's FedWatch tool.