Dollar Holds Gains as US-Iran Conflict Escalates

The dollar index hovered around 101 on Monday, as investors continued to assess developments in the Middle East and their implications for the economic and monetary policy outlook. Tensions between the US and Iran escalated over the weekend, sending oil prices to six-week highs before they pared most of their gains following comments from Iran's foreign ministry indicating that negotiations with the US could continue if the country's national interests are respected. Last week, both CPI and PPI reports came in softer than expected, but the recent surge in oil prices has raised concerns that the disinflation trend could stall. Markets continue to price in one Fed rate hike this year, with the probability of a September move remaining above 60%. Meanwhile, Fed officials have entered the blackout period ahead of next week's FOMC meeting, where policymakers are widely expected to leave the federal funds rate unchanged.

The dollar index traded near 101 on Monday after rising for two straight sessions, supported by escalating tensions in the Middle East that lifted oil prices and fueled concerns over inflation and the prospect of higher interest rates. The US military said it carried out fresh airstrikes against Iran on Sunday following the deaths of three American service members, while Tehran declared that its ceasefire with the US had effectively collapsed and said it intercepted four vessels transiting the Strait of Hormuz over the weekend. Meanwhile, Cleveland Fed President Beth Hammack on Friday joined a growing chorus of Fed officials warning about persistent inflation. Markets are now pricing in around a 53% chance of a Fed rate hike in September, up from 47% a day earlier, though the central bank is still widely expected to keep interest rates unchanged at this month's meeting.

The US dollar index rose to 100.8, rebounding from the one-month low of 100.5 on July 16th and diverging with the retreat for Treasury yields amid a pivot to safer assets. Trade jitters with China retook the spotlight after President Trump claimed that China interfered with the US 2020 presidential elections. The claims jeopardized their truce in economic relations since the exchange of tariffs softened last year, magnifying ongoing shipping bottlenecks amid the war in the Middle East. Trade disputes were also featured between the EU and China, dampening demand for the Euro. On the monetary policy front, FOMC members continued to signal that evidence of stubborn core inflation may warrant a rate hike this year, backed by recent evidence of strong retail sales and low unemployment claim levels. The hawkish remarks prevailed despite soft inflation data for June and a second decline in inflation expectations per the Michigan consumer confidence survey.