During Thursday's Asian trading session, the U.S. Dollar Index (DXY) showed significant strength, rising approximately 0.25% to around 99.50. As military tensions between the United States and Iran escalated further, global financial market risk aversion intensified rapidly, driving capital flows back into U.S. dollar-denominated assets.
Iran retaliated for a prior U.S. military operation near Abbas Port Airport. The Islamic Revolutionary Guard Corps (IRGC) stated it had attacked U.S. military bases and warned of a "more decisive" response if the U.S. continued its military actions. This followed the U.S. Central Command's so-called "defensive strike" on Iranian vessels on Wednesday. Iran subsequently vowed retaliation, heightening market concerns over a broader escalation in the Middle East. With the ongoing military conflict, market optimism for a long-term peace agreement between the U.S. and Iran has notably cooled. Investors are worried that the security of transport through the Strait of Hormuz could be affected, potentially further disrupting the global energy supply chain.
The Strait of Hormuz handles approximately 20% of the world's seaborne crude oil shipments, so heightened Middle East risks quickly pushed international oil prices higher. WTI crude oil reclaimed ground near $89, with volatility in energy markets expanding significantly. Analysts suggest that if the Middle East conflict continues to escalate, rising international oil prices could further increase global inflationary pressures. In this context, the market has begun reassessing the future path of Federal Reserve monetary policy. As rising energy prices could drive a rebound in overall U.S. inflation, investors have notably increased their bets on the Fed maintaining high interest rates or even implementing further rate hikes within the year.
According to data from the CME FedWatch Tool, the market currently assigns a probability of about 43.1% that the Fed will keep rates unchanged this year, with the remaining traders betting on at least one more rate hike. This contrasts sharply with the widespread expectation before the conflict of two rate cuts within the year. Market participants believe the U.S. economy still retains some resilience, and the path of declining U.S. inflation could be interrupted by higher energy prices resulting from the Middle East conflict. This implies the Fed may need to maintain higher interest rates for a longer period to prevent inflation expectations from becoming unanchored again.
Simultaneously, the U.S. Dollar Index strengthened broadly. Among major currencies, the dollar's gains against the Australian Dollar were most pronounced for the day, while it also remained strong against the Euro, British Pound, and New Zealand Dollar. As market risk appetite clearly declined, capital accelerated its flow into safe-haven assets like the U.S. dollar. Risk-sensitive currencies such as the Australian and New Zealand Dollars led the declines, reflecting growing market concerns over global economic growth and the outlook for risk assets. The Euro also faced pressure, weighed down by rising energy prices and concerns about the Eurozone's economic prospects. The market's focus has now shifted to the U.S. April PCE price index data due later. The market anticipates the annual U.S. PCE inflation rate may rise to 3.8%, up from the previous 3.5%. As PCE is one of the Fed's most closely watched inflation indicators, this data could directly influence market judgments regarding the future interest rate path. If the PCE data continues to exceed market expectations, the Dollar Index could gain further support, and U.S. Treasury yields might also continue to climb. Conversely, if the inflation data shows signs of easing, it could alleviate market worries about further rate hikes.
From a daily chart perspective, the Dollar Index has recently re-entered an upward channel and successfully broken through the key resistance area around 99.20. The MACD indicator has formed a bullish crossover again, indicating strengthening medium-to-long-term bullish momentum. The current significant resistance levels above are located at the 100.00 psychological level and the 100.60 area. If Middle East risks continue to escalate, the Dollar Index could strengthen further. The 4-hour chart shows a clear increase in short-term buying momentum for the Dollar Index. The RSI indicator has risen above 60, indicating a short-term bullish bias. The moving average system has realigned into a bullish formation, further improving the technical structure. However, given the index's gains over several consecutive trading sessions, a weaker-than-expected PCE reading could trigger a technical correction. Key support levels to watch below are around 99.00 and 98.60.
Furthermore, movements in U.S. Treasury yields also warrant attention. The recent sustained high levels of the 10-year Treasury yield not only reflect the market's repricing of higher interest rate expectations but also enhance the attractiveness of U.S. dollar assets. Overall, the dollar market is currently in a phase driven by both "safe-haven demand" and "rising inflation expectations." The escalation of U.S.-Iran tensions and the upcoming U.S. PCE data are set to be the core factors determining the dollar's next directional move.
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