The U.S. dollar preserved its recent gains at the start of Asian trading on Thursday as market participants sought greater clarity about whether the U.S.-Israeli conflict with Iran was moving toward de-escalation, while simultaneously cutting back on expectations that the Federal Reserve will raise rates again.
In FX markets, the dollar was flat against the Japanese yen at 159.41 yen, holding close to levels it last reached in 2024. The Australian dollar slipped 0.1% to $0.6943, and the New Zealand dollar was steady at $0.5806.
Comments from Iran's foreign minister on Wednesday added to the uneasy backdrop. He said Iran is reviewing a U.S. proposal to end the war in the Gulf but indicated the country has no intention of holding talks to end the widening Middle East conflict. The mixed signals kept traders alert to headline risk.
With geopolitical uncertainty elevated, the U.S. dollar index - which tracks the greenback against a basket of six major currencies - jumped 0.5% to 99.641. That represented the currency index's largest single-day rise in a week.
Analysts at Westpac captured the prevailing mood, writing: "Markets remain decisively headline driven, with a square focus on weighing up whether recent news marks a genuine de-escalation attempt, or a precursor to a new kinetic equilibrium."
The closure of the Strait of Hormuz earlier in the period sent energy prices higher, prompting traders to reassess previous inflation expectations. That reassessment has increased confidence among some investors that the Federal Reserve will keep policy settings unchanged for the remainder of the year.
Fed funds futures reflect the shift in bets: they priced an implied 70.6% probability that the U.S. central bank will remain on hold at its December meeting, up from a 60.2% likelihood a day earlier, according to the CME Group's FedWatch tool.
In offshore Chinese currency trade, the dollar was flat at 6.9026 yuan after U.S. President Donald Trump said he will meet Chinese President Xi Jinping on May 14-15 during what will be his first visit to China in eight years following a delay tied to the war with Iran.
The euro steadied at $1.1560 after two days of declines. Comments by European Central Bank President Christine Lagarde on Wednesday suggested the ECB could raise interest rates in the euro zone if the war in the Middle East pushes up euro zone inflation for an extended period.
The British pound held at $1.3365, trying to avoid a third straight daily decline after data on Wednesday showed consumer price inflation remained at 3.0% in February - unchanged from January but still above target.
Digital assets showed modest gains in the session, with bitcoin up 0.4% at $71,247.25 and ether rising 0.2% to $2,170.88.
Key points
- Dollar strength persisted amid mixed signals over de-escalation of the U.S.-Israeli conflict with Iran, keeping markets headline-driven - impacts FX markets and risk sentiment.
- Energy price moves after the Strait of Hormuz closure prompted traders to reassess inflation expectations and increase the perceived likelihood the Fed will keep rates on hold for the year - impacts energy and interest-rate sensitive sectors.
- Fed funds futures now price a higher probability the Fed will remain on hold in December, reflecting a marked shift in market rate expectations - impacts fixed income and broader financial conditions.
Risks and uncertainties
- Geopolitical headline risk remains elevated given contradictory signals about talks and proposals related to the conflict in the Gulf - this threatens volatility in FX and energy markets.
- Energy price spikes tied to disruptions such as the Strait of Hormuz closure could revive inflation pressures, complicating central bank decision-making - this affects inflation-sensitive sectors and interest-rate expectations.
- Shifts in market pricing of Fed policy, as reflected in futures, are sensitive to news flow and could quickly reverse if fresh developments alter inflation or geopolitical outlooks - this presents uncertainty for rate-sensitive assets.