US dollar softens as investors weigh Middle East tensions against inflation data

The US dollar weakened on Tuesday as markets grappled with conflicting signals from the Middle East and softer US inflation data. The US dollar index dipped 0.05% to 100.9, while the euro rose 0.09% against the dollar to $1.1424 and the yen declined 0.09% to 162.63 yen. The moves highlight the risks that markets are grappling with as they attempt to price in the latest developments in the Middle East.

The US military has struck Iran for ten straight nights, reigniting tensions and prompting investors to dial back hopes that the conflict would end soon. That kind of escalation typically drives flows into havens such as the dollar. At the same time, efforts to find a diplomatic solution remain active. A senior Iranian official told Reuters on Monday that Tehran had received a proposal from mediators for a 10-day ceasefire.

The lack of clarity on where the conflict is headed has left the dollar in limbo, with investors lacking conviction to place significant bets. A murky inflation outlook has added another layer of uncertainty. Benign US inflation data released last week had already taken some wind out of the currency by curbing bets on further rate hikes. However, questions over where prices go from here persist, as the outlook for global inflation hinges on how soon shipping through the Strait of Hormuz returns to normal and oil markets stabilize.

Traders expect at least one rate hike by the Federal Reserve this year, according to data compiled by LSEG. Brent crude futures dipped 1.1% on Tuesday but have jumped nearly 21% this month. "A sustained depreciation of the US dollar looks more like a 2027 story. We expect the dollar to remain firm over the next few months until the inflation picture becomes clearer," said Jimmy Jean, chief economist and strategist at Desjardins.

The Canadian dollar steadied after dropping to a one-month low, after the US imposed a new tariff of 50% on a wide range of Canadian products in response to what it called Ottawa's "discriminatory treatment" of American-made cars, alcohol and dairy goods. The British pound rose 0.1% against the dollar to $1.3441, on course to snap a three-day losing streak. Andy Burnham became Britain's seventh prime minister in a decade on Monday, and reiterated his commitment to stick to the previous government's fiscal rules. John Healey, the former defence secretary, was appointed the new finance minister.

Burnham has yet to set out details on how he intends to meet his objectives while sticking to election pledges of not raising taxes on working people. "The greatest near-term risk lies with the UK's fiscal outlook and Burnham's plans around the prior government's self-imposed fiscal rules," Scotiabank's chief FX strategist Shaun Osborne wrote. Markets are readying for a European Central Bank meeting later this week. Economists polled by Reuters expect the central bank to hold interest rates steady but still hike at least once more later in the year.