The Dollar Outperforms Its Rivals

• Geopolitics is once again bolstering the US dollar.
• Rising political risks in the UK are weighing on the pound.

The US dollar opened the week with a gap up against the backdrop of escalating geopolitical tensions in the Middle East, expectations of accelerating inflation in the US and weakness in rival currencies. The pound is falling due to the imminent change of prime minister. Speculators are actively selling the yen, testing the government’s patience. Will the Japanese authorities return to currency interventions?

One of the points of the US-Iran agreement was peace in Lebanon. However, Tehran-backed Hezbollah has no intention of honouring it. An enraged Donald Trump promised to resume hostilities if the Islamic Republic did not rein in its ‘dog’. Iran responded by derailing negotiations on its nuclear programme and threatening to close the Strait of Hormuz once again. The mediators – Qatar and Pakistan – managed to put out the fire. Their statement on progress has eased geopolitical tensions.

The fallout from the armed conflict in the Middle East will continue to support the greenback. However, a far more significant driver of its rally is the futures market’s expectations regarding the Fed’s interest rates. CME derivatives indicate a 59 per cent probability of two rounds of monetary tightening in 2026. The chances of a monetary policy tightening in September are estimated at 77%.

Data releases on US PMIs, durable goods orders, GDP and PCE could cause these figures to change. Bringing forward the Fed’s rate hike from September to July would lead to a strengthening of the US dollar. Conversely, if futures market pricing aligns with FOMC forecasts of a single round of monetary tightening, this would weaken the greenback.

GBP/USD briefly touched a low of 2026 due to escalating political risks. The replacement of Prime Minister Keir Starmer by Andy Burnham could take place in the coming days. Markets are concerned that this will lead to a more expansionary fiscal policy. Fears of increased bond issuance are fuelling a sell-off in bonds and putting pressure on cable.

USD/JPY continues to trade very close to 40-year highs. Investors remain unimpressed by Finance Minister Sakuki Katayama’s comments regarding the government’s bold actions. Speculators are betting on the strength of the US dollar. They believe that the fundamental backdrop will deter the authorities from intervening in the currency market.