US Dollar Holds Near Two-Month High as Fed Rate Outlook and Middle East Tensions Boost Demand

The U.S. dollar remained close to a two-month high on Thursday after posting strong gains in the previous session, supported by escalating geopolitical tensions in the Middle East and growing expectations that the Federal Reserve may keep interest rates elevated for longer.

The U.S. Dollar Index (DXY) was little changed during Asian trading hours after reaching its strongest level in nearly two months overnight. Investors continued to favor the greenback as a safe-haven asset amid rising uncertainty in global markets.

Market sentiment received a slight boost after Washington announced that Israel and Lebanon had agreed to implement a ceasefire arrangement. However, concerns remained after reports of Iranian missile attacks targeting Kuwait and Bahrain, along with U.S. military strikes on Iran’s Qeshm Island near the strategically important Strait of Hormuz. These developments kept investors cautious and supported demand for the U.S. dollar.

The dollar also benefited from stronger-than-expected U.S. economic data released on Wednesday. According to ADP, private employers added 122,000 jobs in May, highlighting the resilience of the U.S. labor market despite ongoing economic uncertainties.

Additional support came from the Institute for Supply Management (ISM), which reported that its services PMI rose to 54.5 in May from 53.6 in April, signaling continued expansion in the services sector. Investors paid particular attention to the survey’s prices-paid component, which climbed to its highest level in almost four years, reinforcing concerns that inflationary pressures remain persistent.

As a result, markets have further reduced expectations for near-term Federal Reserve rate cuts. Attention is now shifting toward Friday’s highly anticipated U.S. nonfarm payrolls report, which could provide important clues regarding the future direction of Fed monetary policy.

Meanwhile, the Japanese yen remained under pressure, with the USD/JPY pair trading near 160.00, a level closely watched by traders for potential intervention from Japanese authorities. Policymakers have recently reiterated warnings against excessive currency volatility.

Bank of Japan Governor Kazuo Ueda stated that policymakers may need to consider additional interest rate hikes if inflation risks continue to rise. While widening yield differentials between the United States and Japan have weighed on the yen, expectations of further Bank of Japan policy tightening have helped limit the currency’s losses.

Analysts at ING noted that markets may continue testing higher levels in USD/JPY, adding that June has historically been a seasonally weak month for the Japanese yen.