US dollar feeble as rate hike bets dwindle, Iran war worries grow

SINGAPORE – The US dollar rose slightly on Aug 18 but remained near multi-month lows against its peers as traders reduced their bets on rate hikes, although the threat of an escalation in the Middle East war left sentiment fragile.

The euro eased away from the two-month highs of US$1.161 touched on Aug 17, and was last little changed at US$1.157. The pound sterling was at US$1.352, dipping 0.1 per cent on weak British labour market data, just shy of the three-month peak it hit in the previous session.

Data in the past few weeks has pointed to a softer US economy, including unexpected job losses in July and mild inflation readings, leading investors to scale back expectations of a rate hike by the US Federal Reserve.

Inflation angst

In contrast to the currency markets, bond traders were much more focused on concerns about inflation stemming from the Middle East war, as well as on increased fiscal pressures.

Long-term borrowing costs for major Western economies were at their highest levels in decades on Aug 18. The joint US and Japanese intervention to strengthen the yen in late July has also weighed on the dollar more broadly.

Traders expect a 35 per cent chance of a rate increase at the Fed’s September meeting, compared with 52.2 per cent a week ago, according to the CME FedWatch tool. They are also no longer fully pricing in a hike by the end of 2026.

But analysts remain cautious of where inflation may head, especially with the critical Strait of Hormuz remaining effectively shut and an impasse in the talks to end the US-Iran conflict.

“Inflation has been above target for most of the past five years, and whilst a high 2 per cent annual pace may prove acceptable to the Fed, it leaves the inflation process with little to no breathing room in a world of constant supply shocks,” said Nohshad Shah, head of Europe, the Middle East and Africa fixed-income sales at Citadel Securities.

Iran said it would shift to a “fully offensive” military posture because efforts to negotiate a permanent end to the war with the US have stalled, a senior Iranian official told Reuters as Washington ruled out extending their June ceasefire agreement.

The conflict, which has lasted for more than five months, has stoked inflationary concerns and upended the global interest rate outlook.

Rising worries on Aug 18 helped crimp some of the dollar’s losses through safe-haven flows, with the dollar index, which measures the US currency against its peers, trading 0.1 per cent higher at 99.62.

The Japanese yen was a touch weaker at 159.70 per US dollar, having erased nearly half of the gains from the joint US-Japan intervention at the end of July to lift the fragile yen away from a 40-year low of 163.99.

Traders are focused on the threat of more intervention and the Bank of Japan meeting in September, when the central bank is set to raise interest rates and is considering hiking more aggressively after that, sources told Reuters.

Bonds sell off on oil

Meanwhile, bond yields around the world were on the rise again as traders remained wary of the impact of elevated oil prices and a prolonged closure of the Strait of Hormuz.

Brent crude futures were 0.2 per cent higher at US$91.10 a barrel, touching their firmest levels since July 30.

US 30-year Treasury yields rose to their highest level since 2007, while yields around the world moved higher. Yields move inversely to prices.

“Bond traders appear more concerned about the longer-term inflation outlook than currency traders at present,” said Matt Simpson, senior markets analyst at StoneX. “If bond markets are right – and they have an annoying tendency to be – the US dollar’s pullback may prove short-lived.”

The spotlight has also been on recent US Treasury auctions for the multi-decade yields demanded by investors to absorb Washington’s borrowing needs. Reuters