Dollar Jumps on Renewed Middle East Attacks, Hormuz Closure Fears

The dollar jumped against most major peers in Asian trading Monday, driven by a sharp escalation in Middle East hostilities and renewed fears of a closure of the vital Strait of Hormuz. The move fanned inflation expectations and boosted the likelihood that global central banks will deliver further rate hikes.

U.S. and Iranian forces exchanged heavy missile and drone assaults over the weekend, with Tehran targeting U.S. facilities in states across the Gulf on Sunday and saying it had again closed the Strait of Hormuz shipping route. Oil prices responded immediately, with Brent crude futures rising as much as 4.1% to $79.11 a barrel in Asian trading, before settling around $78.50 later in the session.

The U.S. dollar index, which measures the greenback against a basket of six currencies, rose as much as 0.3% from Friday's close, touching its highest level since July 8. It later gave up those gains, trading down 0.2% at 100.83 in London trading.

Against the yen, the dollar rose 0.2% to 162.05 yen, putting traders on alert for possible intervention from Japanese authorities as the currency continues to languish near 40-year lows. The euro weakened 0.1% to $1.1397-$1.1403, while the British pound slipped 0.1% to $1.3383-$1.339. The Australian dollar fell as much as 0.3% to $0.6928, and the New Zealand dollar eased 0.1% to $0.5757.

Rate Hike Expectations Surge

The renewed conflict has revived fears that rising energy costs could force central banks to tighten policy further. Fed funds futures are now pricing an implied 50.9%-52.1% probability of two or more rate hikes by the time of the Federal Reserve's December meeting, up from a 47.6% chance on Friday, according to the CME Group's FedWatch tool.

"After the flare-up into the end of last week which continued over the weekend, the dollar has responded, and the crude oil price has been the driver," said Tony Sycamore, market analyst at IG in Sydney. "This reinflames concerns that if the energy prices rise from here, we could start to see rate hikes pulled forward."

Inflation data will be the next major test for markets. Westpac analysts noted that inflation risks are likely to remain in focus with the release of U.S. consumer price index data on Tuesday, producer price index gauges the following day, and Federal Reserve Chair Kevin Warsh's testimony before the House and Senate.

Yen Slips on Pension Fund Stance

The Japanese yen came under additional pressure Monday after Reuters reported that Tokyo has no immediate plans to change the asset allocations of its state pension funds. The dollar was last up 0.2% against the yen at 162.05, putting traders back on alert for possible intervention.

The yen and Japanese bonds had rallied Friday after Finance Minister Satsuki Katayama said the government would seek ways to encourage pension funds, including the Government Pension Investment Fund, to make greater investments in Japanese financial assets. However, two government sources told Reuters that while the government is exploring ways to boost such investments within existing allowable ranges, the initiative will not lead to immediate revisions to GPIF's medium-term objectives.

Chris Turner, head of global markets at ING, said intervention was a prospect this week, but added that "intervention alone cannot reverse the current bull trend." He said that "for that to happen, energy prices need to come lower and the Fed must conclude that it does not need to hike rates after all."

Bank of Japan May Revise Outlook

Separately, three sources familiar with the Bank of Japan's thinking told Reuters that the central bank may revise up its economic growth forecast for fiscal 2026 and keep its focus on the risk of an inflation overshoot. Rising costs from a weak yen and strong artificial intelligence demand are offsetting some of the declines in oil prices, the sources said.

Cautious Long-Term View

Despite the dollar's initial jump, some analysts question whether the greenback will sustain gains as large as those seen during previous Middle East crises. Thomas Mathews, head of markets for Asia Pacific at Capital Economics in Wellington, noted that "the dollar was obviously the big winner from the war last time. But it's starting from a pretty different point this time, having strengthened quite a lot and there already having been a fairly lasting repricing of the Fed outlook."

"It's not clear to me the greenback would gain as much this time if the situation continued to worsen, which I think is probably reflected in trade so far," Mathews added.

Cryptocurrencies Fall

In digital assets, bitcoin lost 2.1% to $62,790, while ether shed 2.3% to $1,779. Both assets fell as risk aversion prevailed across markets.