Dollar holds firm as Middle East hostilities lift oil

The US dollar maintained its strength on Wednesday as Middle East tensions escalated, driving oil prices upward and reigniting worries about inflation. The currency's appeal as a safe-haven asset intensified due to rising Treasury yields and heightened expectations of a Federal Reserve rate increase, despite economic data falling short of expectations.

The United States initiated airstrikes on Iran on Tuesday, prompting retaliation and marking the most significant escalation in weeks. Oil prices surged nearly 1% early Wednesday, with Brent futures reaching $95.52 a barrel and US West Texas Intermediate (WTI) crude up 0.89% to $91.02. Kumiko Ishikawa, a senior FX analyst at Sony Financial Group, cautioned that ongoing vigilance was necessary regarding the Middle East situation.

The dollar index, which gauges the greenback's performance against a basket of currencies such as the yen and the euro, stood at 99.67. Economic indicators released overnight, including July JOLTS job openings and the August ISM manufacturing index, were lower than anticipated. However, market participants have adjusted their expectations for a Federal Reserve rate hike following Federal Reserve Chair Kevin Warsh's Jackson Hole speech last week, with a 67% probability of a September hike, up from around 40% a week prior, according to CME Group's FedWatch tool.

The recent U.S. economic data, particularly if weak, could be tempered by the volatile Middle East tensions, Ishikawa noted. Economic data for August, including job openings and consumer price inflation, is expected before the Fed's September 15-16 meeting. The median forecast anticipates the U.S. economy added 56,000 jobs in August, according to economists surveyed by Reuters.

Fed Governor Michael Barr suggested that if inflation does not stabilize soon, raising interest rates would be necessary. The yield on benchmark U.S. 10-year notes climbed to 4.8%, while Japan's benchmark 10-year yield hit 3.0%, after surpassing the 30-year level on Tuesday. Elevated yields compel investors to seek refuge in safe-haven currencies, such as the US dollar, while diminishing the appeal of riskier assets like equities.

The New Zealand dollar experienced a slight decline to $0.5889 ahead of the Reserve Bank's policy decision later in the session, when a rate hike of a quarter point to 2.75% is anticipated. The British pound dipped 0.04% to $1.3509, while the Australian dollar remained stable at $0.7143 against the US dollar. Cryptocurrencies also faced a downturn, with bitcoin falling 0.07% to $77,376.22, and Ethereum decreasing 0.08% to $2,418.26.

The Japanese yen experienced pressure against the greenback, hovering near the 160 mark despite expectations of a Bank of Japan interest rate hike this month. U.S. Treasury Secretary Scott Bessent emphasized the need for decisive monetary measures to tackle yen weakness during a meeting with BOJ Governor Kazuo Ueda. Ueda indicated a desire to discuss with his board whether the economy aligns with forecasts and whether inflation risks have increased.

A hawkish BOJ board member is scheduled to speak later on Wednesday. A rare joint intervention by the U.S. and Japan in mid-July provided temporary relief to the struggling yen, but it has since regained only half of the gains from the coordinated action. Tony Sycamore, a market analyst at IG, opined that there is little prospect of another coordinated intervention until there is de-escalation in the Strait of Hormuz, which would alleviate pressure on oil prices.