US-Iran Clashes Boost Dollar Again

MACRO FRAME

Fiscal dominance has returned to the market, though underlying concerns over the deficit and debt burden are driving investors to demand more risk premium in an environment with persistent inflation. Meanwhile, yields have broadly taken a backseat to equity market performance as corporate earnings growth and expectations have set up bullish conditions to continue through the remainder of the year.

STOCK INDEX FUTURES

Equity index futures are weaker again as renewed US–Iran clashes push oil and global bond yields higher, leaving investors wary of adding equity risk at the start of seasonally difficult September. Brent has extended its rally toward the mid‑$90s, and markets now price about a 68% probability of a September Fed hike, up from roughly 37% a week ago, as Warsh’s Jackson Hole emphasis on inflation combines with a fresh energy shock. The principal counterweight is AI infrastructure demand: Dell has raised annual revenue guidance by $25 billion to $192 billion and now expects $74 billion of fiscal 2027 AI-server revenue, lifting the stock sharply and offering tangible evidence that hyperscaler AI capex is still translating into supplier revenue. Friday’s payrolls report is the next key pivot: strong employment would reinforce the hike case, while a clear slowdown could temper rate expectations despite higher oil.

Watch point: Despite tech volatility, the earnings backdrop suggests bullishness, though a September rate hike remains a near-term risk.

CURRENCIES

US DOLLAR: The USD index is holding its recent gains at 99.75 amid the global bond selloff and renewed US-Iran strikes. While the dollar is finding some strength amid safe haven flows, broad support is coming from expectations that the Fed will hike rates in September. Warsh that inflation is the main concern for the Fed, indicating that further tightening may be necessary. Markets are currently pricing a September rate hike at 68%, while yields continue to rise across the curve. However, a selloff in Treasuries driven by inflation and fiscal concerns has to potential to weigh on the dollar, as rising debt levels and persistent price pressures raise doubts about the long-term appeal of US assets. Near-term rate hike expectations are likely to dominate price direction, while the markets renewed bets of a September hike have added fresh support for the dollar on top of last week’s hawkish data. Labor data this week will be the new test for the dollar and expectations of a September hike.

Watch point: The market remains doubtful over a September hike, though the risk of a move upwards in policy should not be discounted given the current inflationary backdrop.

EURO: The euro is 0.10% lower at $1.1579. Higher oil prices are favoring the dollar over the euro as the US economy is less exposed to energy shock, attracting demand for the greenback. Inflation in the eurozone rose to 3.3% in July,  driven entirely by higher energy prices. However, underlying pressures were rather modest, with core inflation easing from 2.5% to 2.4% amid a drop in services prices inflation from 3.3% to 3.0%. The figures are consistent with the ECB’s read on the economy, leaving the focus for the euro on how much further policy could move higher. Recent reports and commentary from ECB officials have signaled that there is a high chance that the bank holds rates steady for the remainder of the year following a hike in September. Still, money markets are nearly priced for a second move higher in December, seeing 47 bps of total tightening by year-end and 57 bps of tightening by February. Given that a September hike is being taken as a sure thing by markets, any hawkish shift in pricing toward the Fed will weigh on the euro.

Watch point: Broader price direction will be subject to Fed-ECB policy expectations, which is likely to be favorable to the EUR in the near-term.

BRITISH POUND: Sterling is 0.3% lower at $1.3474 as US-Iran strikes and the rise in global bond yields pressured the currency. Now, focus for the pound will shift to parliament’s return for detailed regarding Prime Minister Burnham’s October budget. Amid the current bond selloff, elevated gilt yields have the potential to weigh on the currency further as public finances in the UK remain strained and the gilt market sensitive to changes in fiscal policy.  The case for a rate hike from the Bank of England remains wary following data last week that revealed cooling hiring demand and moderating wage growth. Those dynamics are reducing near-term inflation risks and are factors the BoE will likely acknowledge in upcoming policy meetings as an argument against tightening.  Markets are once again fully priced for a hike by year-end, seeing 32 bps of total tightening.

JAPANESE YEN: The yen gained 0.38% to 159.58 yen per dollar. Overnight, Bank of Japan Governor Ueda said consecutive rate hikes could be a possibility, while hawkish comments from BoJ board member Takata are also helping the yen, despite the impact of rising energy prices on the growth outlook and debt outlook. US Treasury Secretary Bessent on Monday said he believed that the BoJ and government would take action that leads to a stronger yen. Bessent was quoted as saying “I have information that the market doesn’t have, and it’s my belief that the Japanese government and the BoJ will do the things that will lead to a stronger yen.” While the BoJ has been expected to lift rates in September, Bessent’s comments could effectively lock the bank into doing so and put pressure on it to step up hikes. Still, Bessent’s comments have not added much support to the currency as it broke the 160 level for the third straight session. As such, markets continue to appear unfazed by verbal intervention efforts and remain focused on unfavorable fundamentals and interest rate differentials with the US. Markets are pricing a 77% chance of a September hike. Failure to hike at the September meeting would renew pressure on the currency and send the yen back toward the 162 area.

Watch point: Failure to raise rates at the Bank of Japan’s September meeting could see the yen drop toward the 162 level.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.7150. The Aussie is facing pressure from today’s continuation of the bond selloff, although domestic data could contain losses. Traders have significantly repriced expectations of a September rate hike as recent data has suggested that inflationary pressures in the economy have not subsided to the degree in which the Reserve Bank of Australia had expected. July’s CPI print and household spending figures came in hotter-than-expected and the details offered no reprieves for policymakers. Like the Fed, the risk of a rate hike at September’s meeting should not be discounted. Money markets now see a 52% chance of a hike at the September. However, Q3 inflation figures will continue to serve an outsized role in determining RBA policy and given that the September policy meeting is a month before the release, policymakers could wait until that data arrives before making any decisions.

Watch point: June’s hiring figures have offered some relief on inflationary pressures, though ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields edged lower in the US, though the selloff continued across markets around the globe as the Middle East energy shock layers fresh inflation risk onto already elevated fiscal and term-premium concerns. The US 10-year yield has recently touched 4.81%, its highest level since late 2023 and close to the 5% threshold that could trigger a broader risk-asset re-pricing; the 2-year is at an 18-month high, Japan’s 10-year remains above 3% for the first time in three decades, and German and UK benchmark yields are at their highest levels since 2011 and 2008, respectively. Brent is at a one-month high and European natural gas is above €70/MWh, its highest since early 2023, raising worries of a stagflationary shock. The structural issue is competition for capital: large sovereign deficits and heavy AI/data-centre bond issuance are both increasing duration supply, leaving the market to demand a higher return to fund governments and hyperscalers. The immediate cross-asset risk is a sustained US 10-year move above 5%, which would tighten financial conditions and pressure equity valuations, especially long-duration technology

Watch point: For Fed policy, without any forward guidance, the September decision will likely remain a close call.

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