Dollar climbs to two-week high on Middle East tensions and rate divergence

The US dollar advanced to a two-week high on Wednesday, driven by escalating Middle East tensions and shifting expectations for global monetary policy. The dollar index gained 0.11 per cent to 99.76, touching 99.808 earlier in the session, its strongest level since mid-August.

Investors are flocking to the US currency amid a renewed exchange of fire between the US and Iran. The greenback traditionally strengthens during energy shocks, as the American economy remains less vulnerable to oil price spikes than European or Japanese counterparts.

This dynamic is compounded by widening policy divergences among major central banks. Market participants now assign a 70 per cent probability to a Federal Reserve rate hike in September, a sharp increase from 40 per cent just a week ago, according to CME Group data.

Conversely, the European Central Bank is widely anticipated to conclude its tightening cycle following next week’s expected rate increase. George Brown, a senior economist at Schroders, noted that the Fed will likely just be beginning to raise rates while the ECB finishes its cycle.

"That should widen rate differentials in favour of the dollar and lead to a weaker euro by year," Brown stated. Consequently, Schroders forecasts the euro will decline to $1.10 by the end of the year, having already slipped 0.16 per cent to $1.1575 on Wednesday.

Yield Pressures and Yen Volatility

Rising US yields present a complex backdrop for the dollar’s momentum. The benchmark 10-year Treasury yield climbed to 4.812 per cent, its highest point since November 2023, before settling at 4.804 per cent.

Persistent inflation and concerns over the US fiscal trajectory threaten to trigger Treasury selloffs. Such movements could ultimately undermine the long-term appeal of US assets and weigh on the dollar despite current safe-haven demand.

In Asia, the Japanese yen traded at 159.50 per dollar, recovering slightly after testing levels not seen since late July. The currency remains perilously close to the psychologically significant 160 threshold, prompting ongoing scrutiny of the Bank of Japan’s policy path.

Bank of Japan Governor Kazuo Ueda indicated that consecutive rate hikes remain a possibility. US Treasury Secretary Scott Bessent recently expressed strong support for decisive monetary actions to address yen weakness during a meeting with Ueda.

However, further direct market action remains unlikely in the near term. Tony Sycamore, a market analyst at IG, observed that coordinated intervention is improbable until de-escalation in the Strait of Hormuz reduces upward pressure on oil prices.

Elsewhere, the New Zealand dollar fell 1.01 per cent to $0.5844, marking its lowest valuation since mid-August. This decline occurred even after the central bank raised its official cash rate by 25 basis points to 2.75 per cent, a move markets deemed insufficiently hawkish.