Renewed tensions between the United States and Iran have bolstered the U.S. dollar, which is acting as a safe-haven asset for investors. The conflict has also driven up global oil prices, with Brent crude futures climbing over 1.3% to reach $95.31 a barrel. This surge in oil prices is intensifying fears of inflation, making a Federal Reserve rate hike more probable. The likelihood of a Fed interest rate hike this month rose significantly to 33.7% on Wednesday, up from 25.7% on Tuesday, according to the CME FedWatch Tool. Some analysts, like Keith Lerner of Truist Advisory Services, note that higher oil prices are directly impacting interest rates, complicating the Fed's policy decisions.
Bond markets are reflecting this anxiety, with the two-year U.S. Treasury yield hitting a 17-month high. The 10-year Treasury yield is at 4.65%, near its May highs, while the 30-year Treasury yield has been above 5% for its longest stretch since 2007. Higher yields make borrowing more expensive for governments, businesses, and households, which can dampen economic growth. Elevated rates also tend to negatively affect high-flying tech stocks and rate-sensitive sectors, such as small-cap stocks tracked by the Russell 2000 index.
The Japanese yen is particularly vulnerable, languishing near a 40-year low at 163.1 per dollar. Despite reports of the Bank of Japan considering faster rate hikes, the yen's weakness is attributed to broad-based dollar strength and Japan's comparatively low interest rates. The euro, Australian dollar, and New Zealand dollar have also softened against the strengthening greenback. Analysts believe that without a softer message from the Fed or a significant shift in Japan's rate policy, a lasting yen rebound is unlikely, especially given the rising energy prices and expectations of a more hawkish Fed meeting next week.
Energy prices are a critical factor, returning to pre-ceasefire levels, with gasoline potentially reaching $4.15 to $4.25 a gallon in the coming weeks. Joseph Capurso, head of international economics and foreign exchange at Commonwealth Bank of Australia, highlights that lower oil inventories now, compared to the start of the conflict five months ago, make shortages more likely. This situation exacerbates the negative economic impact of high energy prices, further supporting the U.S. dollar. The European Central Bank is expected to keep rates steady this week but may hike in September due to inflation concerns.
