The US dollar firmed to a one-week high on Thursday as fresh airstrikes between Iran and the US dented hopes for a peace deal, with the dollar index strengthening 0.13% to 99.426, near its highest level since May 21. According to Reuters reports, Iran's Revolutionary Guards said they targeted a US airbase after the US military carried out strikes aimed at an Iranian drone operation near the Strait of Hormuz. President Donald Trump rejected reports he was close to a compromise deal with Tehran, with the situation remaining "very fickle and very murky" as noted by Aidan Yao, senior investment strategist for Asia at Amundi Investment Institute. As reported by Reuters, the dollar's strength reflects growing uncertainty about potential progress in Middle East negotiations. Historically, periods of heightened conflict in the Middle East have caused the US Dollar Index (DXY) to strengthen by an average of 2-3% within a few weeks, creating significant downward pressure on the Australian dollar.
The Australian dollar traded around 0.7160 against the US dollar in Asian hours on Wednesday, extending gains for a second day despite softer-than-expected inflation data. The Australian Bureau of Statistics reported CPI rose 4.2% year-on-year, below the 4.4% consensus and down from 4.6% in the 12 months to March 2026. Monthly CPI printed at 0.4% in April versus 1.1% previously, while the RBA Trimmed Mean CPI rose 0.3% on the month and 3.4% on the year. This downside surprise is significant for the short-term outlook, as the market had priced in a higher number. Given the softer Australian inflation data, the Reserve Bank of Australia will be less inclined to raise interest rates, removing a key pillar of support for the Australian dollar. As of today, May 27, 2026, money markets have already reduced the probability of a rate hike in the third quarter from 40% down to just 15%.
Market participants believe higher Treasury yields are improving the dollar's appeal as geopolitical tensions escalate. The 10-year U.S. Treasury yield has risen roughly 50 basis points since the conflict began, while the 2-year yield, closely tied to Federal Reserve policy expectations, has jumped nearly 70 basis points. Higher yields generally attract capital flows into dollar-denominated assets, supporting the currency's strength. As reported by Reuters, strategists at major global investment firms believe widening interest-rate differentials between the United States and other developed economies could further strengthen the dollar against currencies such as the euro and Japanese yen. The combination of rising Treasury yields and safe-haven demand continues to support the dollar's strength against major currencies.
The escalating tensions have broad market implications, with major currencies weakening against the dollar. The euro was 0.2% lower at $1.1601, while the pound was down nearly 0.3% at $1.3387. The risk-sensitive Australian dollar weakened 0.3% to $0.7120, a one-week low, and the New Zealand dollar was down 0.4% at $0.5876. The yen weakened to as far as 159.610 per dollar, the lowest since April 30 and within sight of the 160 level that triggered intervention by Japanese authorities last month. Markets are pricing a roughly 70% chance of a quarter-point interest rate rise at the BOJ's June 15-16 policy meeting. Cryptocurrencies also declined as risk sentiment deteriorated, with Bitcoin down 3% to $72,878.72 and Ethereum falling 4.2% to $1,974.68. The flight-to-safety sentiment traditionally strengthens the US Dollar, with analysts expecting this trend to increase market volatility and make options pricing more expensive.
Oil prices rebounded as hopes of a swift resolution to the war faded, with investors now increasingly expecting the greenback to break higher as the Federal Reserve shifts its focus to battling inflation amid elevated energy prices. Amundi expects oil prices to hover around $100 a barrel on average over the second quarter. With the Strait of Hormuz not fully reopened, oil prices are expected to stay elevated, pushing US inflation further from the Federal Reserve's 2% target. The latest Consumer Price Index (CPI) data shows inflation at 3.4% year-over-year, still well above the Federal Reserve's 2% target. This situation reinforces the view that the Fed will not be in a rush to lower interest rates. The CME FedWatch Tool shows that traders are now pricing in only one potential rate cut by the end of 2026, a significant shift from earlier expectations. This outlook provides strong fundamental support for the US Dollar, while the disinflationary trend in Australia is likely to keep the RBA on hold through its next meeting.
