Dollar Holds Near Two-Month High as Rate Hikes and Iran Diplomacy Dominate Markets

The dollar held close to its strongest level in two months on Wednesday, supported by expectations of near-term interest rate increases, even as easing oil prices and diplomatic efforts to end the Middle East war kept investors cautious.

The euro traded at $1.1446 in early deals, hovering near its weakest since late July, while sterling stood at $1.3337. The dollar index, which tracks the US currency against six major peers, was at 100.56.

A wave of rate hikes and hawkish signals from major central banks has moved to the centre of currency markets, as the US-Israeli conflict with Iran pushes oil prices higher and intensifies inflation concerns. Federal Reserve officials have flagged the possibility of further increases if inflation does not cool.

"The dollar's support from rates looks durable, but futures already price more tightening than the Fed's own projections, so the dollar now needs the data to confirm it," said Kieran Williams, head of Asia FX at Intouch Capital Markets.

Oil remains in focus, with Brent crude futures at $99.22 a barrel on hopes that diplomacy at the UN General Assembly could open the way to a resolution of the Middle East war. Brent has climbed 37% since the conflict began at the end of February.

US President Donald Trump warned he could annihilate Iran if no deal is reached to end the war, but also suggested an agreement could come soon amid the diplomatic push at the UN.

"The good news is that oil prices have moderated somewhat from the highs but the path forward remains unclear given the lack of clarity around a possible resolution of the conflict," said Michael Wan, a currency analyst at MUFG.

Investors are also awaiting a high-stakes meeting between Trump and Chinese President Xi Jinping, as the two leaders seek stability in a relationship strained by a wide range of issues.

The Japanese yen was at 157.55 per US dollar, with traders wary of intervention after the Bank of Japan's rate hike to a 31-year high last week was judged insufficiently hawkish. Two dissenting votes and the absence of a clear hawkish signal fuelled doubts over how quickly the BOJ will tighten policy, especially after the Fed raised rates last week and flagged more ahead.

Japanese markets are closed for a holiday, and analysts see the low-liquidity period as an optimal time for authorities to intervene if needed.

"The BOJ hike didn't narrow the (yield) gap because the Fed hiked by the same amount two days earlier, so the lean is still higher," Williams said. "160 (per US dollar) remains the risk, but officials have reportedly moved away from telegraphing intervention and from any fixed level, so the cap could come earlier and in other forms."