Dollar Poised for Weekly Decline as Soft Inflation Data Overrides Safe-Haven Bids

The dollar steadied on Friday but remained on track for a weekly decline, caught between conflicting forces: a benign U.S. inflation reading that eroded expectations for near-term Federal Reserve rate hikes, and intensifying military exchanges between Iran and the United States that spurred safe-haven bids for the currency.

The dollar index, which measures the greenback against six major peers, was little changed at 100.69, set for a weekly drop of roughly 0.3%. The index touched a one-month low earlier in the week as traders scaled back bets on an imminent rate increase, but safe-haven flows have since helped support the currency.

Iran and the United States exchanged intensifying fire over the week, largely unraveling a truce reached last month. The escalation drove oil prices near one-month highs and provided a floor under the dollar. "There has been no let-up in the escalation of the conflict in the Middle East which continues to curtail appetite to sell the dollar," Derek Halpenny, senior currency strategist at MUFG, told Reuters. "U.S. data releases yesterday have also helped curtail dollar selling."

Data on Thursday showed U.S. retail sales rose slightly in June, with lower gasoline prices weighing on service station receipts but online spending surging. The figures prompted economists to upgrade their second-quarter growth estimates and underscored the economy’s resilience, alongside other data pointing to labor market stability.

Even so, traders are now pricing in just 26 basis points of total rate hikes by December, down from 44 basis points earlier in the week, according to the CME FedWatch tool. The implied probability of a move at the Fed’s July meeting fell to 11% from 25% last week.

"A softer-than-expected U.S. inflation report this week led traders to cut bets on imminent rate hikes," reported Reuters. The consumer price index showed inflation cooled in June, leading most economists to expect the Fed will keep rates unchanged later this month. However, policymakers are wary of placing too much weight on a single month of improvement after several months in which inflation moved in the wrong direction. Federal Reserve Vice Chair Philip Jefferson has suggested he would be open to raising rates if inflation does not improve in the near term.

"We expect neither rate hikes nor cuts in 2026," Tani Fukui, senior director of global economic and market strategy for MetLife Investment Management, told Reuters.

In currency markets, the euro was flat at $1.145, set for a 0.3% weekly rise. Sterling edged up to $1.346, on course for a 0.5% weekly gain — its third straight week of gains as concerns over Britain’s fiscal outlook continued to fade. The Japanese yen was slightly stronger at 162.26 per dollar, but remained close to the 40-year low of 162.84 touched at the start of the month. Japanese Finance Minister Satsuki Katayama reiterated the government’s readiness to take decisive action against excessive moves, according to Reuters, keeping traders on alert for potential intervention.

OCBC strategists noted that the U.S. dollar remains the highest-yielding safe-haven currency in the G10 complex. "Near-term FX price action is likely to continue reflecting the 'USD smile' framework, under which the greenback tends to outperform when markets price either stronger U.S. growth and higher rates or a rise in global risk aversion," they wrote.

The Australian dollar was poised for a third straight weekly gain despite slipping 0.24% on the day to $0.6981, as risk-off sentiment prevailed and global stocks fell sharply, Reuters reported. China’s yuan weakened from a one-month high against the dollar but remained on track for its third consecutive week of gains, according to the same report.

Investor attention now turns to a scheduled speech from U.S. President Donald Trump later Friday, which could provide further direction to currency markets.