US Dollar Strengthens Amid Scrutiny of Tenuous Middle East Peace Negotiations

US Dollar Edges Higher Amid Uncertainty Over Middle East Peace Talks

The US dollar experienced a slight increase on Monday, following a modest weekly loss, as investors sought to make sense of the latest developments in the Middle East peace talks. The US and Iran have been engaged in a war of words over the weekend, with the US military striking Iranian air defenses and the Islamic Revolutionary Guard Corps targeting a US air base in response.

The dollar index, which measures the currency against six peers, edged lower last week on expectations that a deal between the US and Iran to reopen the Strait of Hormuz was imminent. The closure of the key oil artery has led to higher oil prices and a worsening inflation outlook, prompting some analysts to predict that the Federal Reserve would raise interest rates this year.

However, the dollar index rose on Monday by 0.184% to 99.195 after Iran's Tasnim news agency announced that Tehran's negotiating team was suspending exchanges of messages with the US through mediators due to attacks on Lebanon. US President Donald Trump later stated that he had spoken with Iran-aligned Lebanese militia group Hezbollah through intermediaries and secured a pledge that it would not attack Israel, which partially offset the dollar's gains.

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The greenback had initially rallied at the onset of the conflict, which began on February 28, due to safe-haven demand and the US economy's relatively limited exposure to energy-driven inflation. However, it has since given back some of those gains due to uncertainty surrounding the conflict's trajectory.

Currency Market Update

Currency markets are in wait-and-see mode following the US military's announcement that it had struck Iranian air defenses over the weekend. Should the Strait of Hormuz reopen to traffic and oil prices fall, the dollar is likely to weaken in the near term, and risk-sensitive currencies such as the Swedish crown may outperform, according to Tommy von Bromsen, FX strategist at Handelsbanken.

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Markets are betting that the US central bank's next move will be to raise its benchmark interest rate, compared with expectations for a cut before the start of the Iran war, given rising energy prices and the impact they will have on inflation, as well as a still-resilient jobs market. The release on Friday of the monthly US employment report could help sway what the Fed will do in the near term, with economists predicting a gain of 85,000 jobs in May and no change in the current 4.3% unemployment rate.

Fed Governor Jerome Powell, whose term as head of the central bank formally ended last month, warned in a speech on Sunday about the politicization of monetary policy. Powell has decided to remain on the Fed's Board of Governors in part due to ongoing threats to the central bank's independence.

Markets are highly anticipating a speech by Bank of Japan Governor Kazuo Ueda on Wednesday for possible signals as to whether the central bank will proceed with a rate increase the following week. While there is no consensus yet within the BOJ on the decision, a pause in the central bank's taper of government bond purchases is increasingly seen as a preferred option, according to two sources familiar with the deliberations.

The yen weakened 0.28% to 159.710 per dollar, close to the psychologically important 160 level that has seen intervention by Japanese authorities to strengthen the currency. "It seems like 160 is where they draw the line," said Handelsbanken's von Bromsen. "I think there will be intervention if we approach that level again."