Investing.com – The U.S. dollar edged lower in early European trade Monday, but remained elevated amid uncertainty over Federal Reserve rate cuts and with heightened Middle East tensions denting risk appetite.

At 04:00 ET (09:00 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% lower at 105.710, near its highest levels since early November, having climbed 1.7% last week, its biggest weekly gain since September 2022. 

Dollar boosted by safe haven demand

The dollar has seen some profit-taking early Monday, but still remains in demand after the Iranian strike on Israel over the weekend increased safe haven demand, amid fears of a wider regional conflict on top of the war between Israel and Hamas in Gaza.

“With Western allies urging restraint, the market is taking the position that the Netanyahu government will avoid the more aggressive and escalatory responses of a direct attack on Iranian military or nuclear facilities,” analysts at ING said, in a note.. 

“Yet it looks too early to conclude that Middle East tension has found some kind of new equilibrium, and we suspect implied FX volatility will stay better bid for some time,” ING added. “The episode also serves as a reminder that the dollar is the best safe-haven currency right now—offering liquidity, high yields, and protection from US energy independence.”

Fed to delay rate cuts further?

The greenback had also benefited last week from the release of the hotter-than-expected release, which raised expectations that the will need to leave interest rates at current levels for longer to avoid a potential resurgence of inflation. 

Investors are currently pricing in just 50 basis points of interest rate cuts in 2024, a sharp drop from the 150 basis points priced in at the start of the year.

data for March are due later in the session, with the monthly figure seen rising 0.4%, a slowing in growth from the 0.6% seen the prior month.

“After last week’s high US inflation data it is doubtful that any kind of weakness in retail sales data today can substantially move the needle on expectations for the Fed this year,” ING added.

Euro bounces off five-month low

In Europe, rose 0.2% to 1.0659, but not far from the five-month low of 1.0622 reached on Friday.

Dovish comments from a number of European Central Bank officials have pointed to a rate cut in June, likely before the Fed starts its rate-cutting cycle.

Eurozone inflation currently resides just above the ECB’s 2.0% medium-term target, but in the bloc is very weak, considerably below the levels seen across the pond. 

Data released earlier Monday showed that eurozone climbed 0.8% on the month in February, but this still represented an annual fall of 6.4%.

rose 0.3% to 1.2487, with sterling recovering slightly after recording last week its largest weekly percentage drop since mid-July.

This week sees the release of U.K. unemployment data on Tuesday and the latest consumer prices the following day.

“Given that market pricing for a June BoE rate cut is just 31%, conversely, any downside surprise on wages or services data could hit sterling quite hard,” ING said. 

Yen falls to 34-year low

rose 0.3% to 153.81, just below the 34-year high seen earlier in the session.

This yen weakness has traders on guard for any potential intervention in currency markets by the Japanese government, following repeated warnings from government officials in recent weeks.

edged higher to 7.2386, largely treading water after the People’s Bank kept medium-term lending rates unchanged.

Investing.com– Most Asian currencies weakened on Monday with the Japanese yen testing new 34-year lows, while increased safe haven demand, in the wake of an Iranian strike on Israel, put the dollar at more than five-month highs.

The dollar was also boosted by the prospect of higher-for-longer U.S. interest rates, following strong inflation readings and hawkish Federal Reserve signals from last week. 

Sentiment towards Asia was further dulled by weak economic prints from China. China’s disinflation worsened in March, while export and import figures missed expectations for the month.

Japanese yen weak, USDJPY blows past 153

The yen was among the worst performers for the day, with the pair rising 0.3% to a 34-year high of 153.77. The currency, which usually benefits from increased safe haven demand, was largely supplanted by gold and the dollar as a risk-averse trade.

Yen weakness put traders on guard for any potential intervention in currency markets by the Japanese government, following repeated warnings from government officials in recent weeks.

Levels above USDJPY 153 had attracted a record amount of intervention by the Japanese government in 2022, causing a sharp pullback in the currency pair.

Japanese is also due later this week for more cues on the economy. 

Dollar at 5-½ month high on rate fears, Iran-Israel jitters 

The and steadied in Asian trade after surging to 5-½ month highs on Friday. 

The greenback was boosted by safe haven demand after Iran launched a large-scale missile and drone strike against Israel. 

But the damage from the strike appeared minimal, and Iran also signaled that it had concluded its attack against Israel. Israeli ministers also reportedly said that they were not considering an immediate retaliation over the strike.

The dollar was also buoyed by rapidly declining bets that the Fed will cut interest rates in the first half of 2024. This came on the back of strong inflation readings for March.

Weak risk appetite and higher-for-longer U.S. rates weighed on most Asian currencies. The Chinese yuan’s pair tread water after the People’s Bank kept medium-term lending rates unchanged. 

The Australian dollar’s pair rose 0.4%, recovering from a plunge to two-month lows on Friday, while the South Korean won’s pair rose 0.3%.

The Indian rupee was fragile with the pair falling from levels close to record highs, while the Singapore dollar’s pair moved sideways. 

By Saqib Iqbal Ahmed and Laura Matthews

(Reuters) – A rally in the U.S. dollar is accelerating, as stubborn inflation sows doubts over how aggressively the Federal Reserve will be able to cut rates this year compared to other central banks.

The , which measures the greenback against a basket of six major currencies, is up 4.6% this year and stands near its highest levels since early November. The index rose 1.7% last week, its biggest weekly gain since September 2022.

The greenback is advancing as market participants grow convinced the Fed will need to leave interest rates at current levels for longer to avoid a potential resurgence of inflation. Last week’s stronger-than-expected consumer price data bolstered that view: investors late Friday were pricing in just 50 basis points of interest rate cuts in 2024, futures markets showed, compared to 150 basis points priced in at the start of the year.

By contrast, investors believe some global central banks – including the European Central Bank, the Bank of Canada and Sweden’s Riksbank – could have a freer hand to ease monetary policy. That is a shift from a few months ago, when many believed the Fed would be among the first to cut rates.

“We had a fairly clear path that the Fed would likely be the first actor. The data that we have received really does undermine that,” said Eric Leve, chief investment officer at wealth and investment management firm Bailard. “I can see obvious reasons why the dollar could strengthen further.”

Yield differentials between the U.S. and other economies have widened in recent weeks, contributing to the greenback’s rally as higher yields boost the allure of dollar-denominated assets. The two-year U.S.-German bond spread stood at its widest since 2022 late Friday, LSEG data showed, a day after the European Central Bank signaled it could cut rates as soon as June.

Bullish investors have increased their bets on the dollar, while bears have wavered. Net bets on the dollar in futures markets stood at $17.74 billion in the latest week, data from the Commodity Futures Trading Commission showed, the highest level since August 2022.

Central bank policy has diverged in recent months, reflecting economies’ varying struggles to contain inflation.

The Swiss National Bank reduced rates by 25 bps in March, its first cut in nine years. Sweden’s central bank has signaled it could cut rates in May if inflation keeps falling, while the Bank of Canada recently suggested it was ready to ease.

Central banks in Australia, Britain and Norway, on the other hand, appear less eager to loosen monetary policy.

Japan’s yen, meanwhile, has weakened to a near 34-year low against the dollar – though the country has recently ended eight years of negative interest rates. The Bank of Japan has ruled out using rate hikes to support the currency.

Eric Merlis, managing director and co-head of global markets at Citizens, believes the dollar could continue appreciating broadly on the back of a more hawkish Fed relative to the ECB. The euro has fallen 3.6% against the greenback this year.

“The dollar has room to strengthen. We have the strongest economy right now, in general, the trajectory of yields has been going up,” he said. “Whereas Europe is struggling in terms of growth.”

A stronger dollar could complicate the inflation fight for other economies as it pushes down their currencies, while helping the U.S. tamp down consumer prices by tightening financial conditions.

Dollar strength can also be a headwind for U.S. multinationals as it makes it more expensive to convert their foreign profits into dollars, and make exporters’ products less competitive abroad.

Other factors may also be driving the dollar. The U.S. currency is a popular destination for investors during times of geopolitical uncertainty, which has sharpened in recent days on fears over a widening conflict in the Middle East.

Brian Liebovich, chief dealer for global foreign exchange at Northern Trust (NASDAQ:), believes the dollar may receive a boost from the Fed allowing assets to run off its balance sheet, a process known as quantitative tightening.

The Fed is currently allowing up to $60 billion per month in Treasury bonds and up to $35 billion per month in mortgage bonds to mature and not be replaced.

While Northern Trust expected the dollar to strengthen by up to 5% going into the U.S. presidential election, “market activity since the initial dollar rally this week suggests that move could happen sooner than expected,” Liebovich said.

Others are less certain the dollar has more room to run. Shaun Osborne, of Scotiabank, wrote that the dollar’s recent strength means investors have priced in a good deal of bullish news.

Rates and spreads are in the dollar’s favor, however, meaning “the trend at the moment suggests the USD will stay better supported,” he said.