Dollar Holds Steady as Middle East Tensions and Central Bank Signals Drive Market Focus

BY COMFORT OGBONNA

The U.S. dollar traded largely unchanged on Monday after posting a weekly decline, as investors weighed escalating geopolitical tensions in the Middle East alongside expectations for key central bank decisions and upcoming U.S. economic data.

The dollar index, which measures the greenback against a basket of six major currencies including the euro and yen, edged slightly higher by 0.04% to 99.05. This followed a 0.4% decline the previous week, when markets were buoyed by hopes of progress toward easing tensions between the United States and Iran.

Currency markets remain highly sensitive to developments in the Middle East, where renewed conflict and diplomatic uncertainty have intensified volatility across energy and foreign exchange markets. Oil prices surged in early trading after Israel ordered additional troop movements deeper into Lebanon amid its ongoing confrontation with Hezbollah, while both the United States and Iran reported new military strikes against each other.

The situation has raised concerns about the security of the Strait of Hormuz, a critical global shipping route for oil exports. Any disruption to traffic through the waterway is seen as a major risk to global energy supplies and inflation expectations, which in turn influences currency and interest rate outlooks.

Market participants are also closely watching the upcoming U.S. nonfarm payrolls report for May, which is expected later this week. Economists polled expect the unemployment rate to hold at 4.3%, with job growth of around 85,000 positions. The data is likely to play a key role in shaping expectations for Federal Reserve policy, particularly as officials assess the impact of geopolitical risks on inflation.

Joseph Capurso, head of foreign exchange strategy at Commonwealth Bank of Australia, said currency movements would be heavily influenced by both geopolitical developments and upcoming U.S. labor market data.

“USD will be heavily influenced by developments in the U.S.-Iran war and the U.S. nonfarm payrolls report for May,” Capurso said. He added that once tensions surrounding the Strait of Hormuz ease, oil prices are likely to stabilize, shifting market focus back toward interest rate differentials as the primary driver of the dollar.

The euro slipped 0.13% to $1.1644, while the Japanese yen weakened 0.13% to 159.48 per dollar. The British pound also edged lower, falling 0.07% to $1.3449. Commodity-linked currencies showed mixed performance, with the Australian dollar steady at $0.7182 and the New Zealand dollar declining 0.33% to $0.5968.

The broader market tone reflects uncertainty over the next move by the U.S. Federal Reserve. Traders are increasingly pricing in the possibility of interest rate increases rather than cuts, as concerns grow that prolonged geopolitical instability could fuel inflation through higher energy prices.

Fed officials have adopted a cautious stance in recent communications. Outgoing Governor Jerome Powell warned over the weekend about the risks of political influence on monetary policy, while several other policymakers, including Beth Hammack, Lorie Logan, and Mary Daly, are scheduled to speak later in the week. Their remarks are expected to provide further insight into the central bank’s balancing act between inflation control and economic stability.

Chris Weston, head of research at Pepperstone, said recent commentary from Fed officials suggests a flexible approach to policy decisions.

“Officials remain open to both rate hikes and rate cuts depending on incoming data,” Weston said, noting that the evolving geopolitical backdrop adds another layer of complexity to the policy outlook.

Attention is also turning to manufacturing data, with the Institute for Supply Management’s Purchasing Managers’ Index expected to show a modest improvement to 53 in May, up from 52.7 previously. While still indicating expansion, the reading is closely monitored for signs of slowing momentum in the U.S. economy.

Elsewhere, European Central Bank board member Isabel Schnabel warned that the growing use of dollar-pegged stablecoins could weaken the euro’s influence and limit the ability of some countries to conduct independent monetary policy. She reiterated earlier comments suggesting that the ECB may need to consider further rate increases depending on global financial conditions.

In Japan, markets are awaiting a key speech from Bank of Japan Governor Kazuo Ueda later this week. Investors are looking for signals on whether the central bank will proceed with another interest rate increase in the near term, as debate continues within the BOJ over the timing and scale of policy normalization. A pause in government bond purchase reductions is increasingly seen as a possible compromise among policymakers.

As global markets navigate a complex mix of geopolitical risk, inflation concerns, and shifting monetary policy expectations, currency traders are likely to remain highly reactive to both political developments and economic indicators in the days ahead.