From Easing Middle East Risks to a Hawkish Fed: The Dollar Reclaims Center Stage
Market Overview
The market narrative has shifted significantly this week.
Until recently, the dominant theme was:
“Middle East tensions.”
This week, however, the focus has moved to:
“Expectations of further Federal Reserve tightening.”
The United States and Iran completed the signing of a memorandum of understanding, initially creating a broad risk-on sentiment across global markets.
However, the Federal Reserve subsequently adopted a more hawkish tone than expected, accelerating demand for the U.S. dollar in the foreign exchange market.
At present, market movements are being driven far more by:
U.S. monetary policy
than by
the easing of Middle East tensions.
Middle East Developments
The United States and Iran have finalized the signing of a memorandum of understanding.
Initially, markets welcomed:
- An extension of the ceasefire
- Greater stability in the Strait of Hormuz
- Normalization of global oil supply
As a result, markets reacted with:
- Lower oil prices
- Higher equity prices
- A weaker U.S. dollar
However, the agreement is only a 60-day temporary arrangement.
In addition, Iran postponed further negotiations with the United States, citing:
“Israeli military operations in Lebanon.”
Iran also canceled plans to send a delegation to Switzerland.
As a result, market participants increasingly recognize that:
The Middle East issue has not been fully resolved.
The Fed Takes Center Stage
The primary market driver is now the FOMC.
At the latest meeting, the Fed’s Summary of Economic Projections (SEP) showed a dramatic shift.
The median projection moved from:
One rate cut this year
to
One rate hike this year.
This represented a major surprise for financial markets.
The Federal Reserve remains highly concerned about inflation and has significantly pushed back against expectations of policy easing.
U.S. Dollar Outlook
The bullish trend in the dollar continues to strengthen.
The U.S. Dollar Index has risen to its highest level since May of last year.
Compared with dollar selling triggered by easing Middle East risks, dollar buying driven by the Fed’s hawkish stance has become overwhelmingly dominant.
Market attention is gradually shifting away from:
“When will the Fed cut rates?”
toward:
“Could the Fed raise rates again?”
USD/JPY
USD/JPY remains firmly entrenched in an uptrend.
The pair has decisively broken above the psychologically important 160.00 level.
During New York trading, it climbed as high as 161.81.
The pair continues to trade above 161.00, reinforcing the strength of selling pressure on the Japanese yen.
The main drivers include:
- The Fed’s hawkish policy stance
- The wide U.S.–Japan interest rate differential
- Ongoing yen carry trades
The Biggest Risk: Intervention
Despite the bullish outlook, USD/JPY requires caution.
The latest high stands well above the previous intervention-related high of 160.72, recorded on April 30.
Japanese Finance Minister Katayama has continued issuing strong verbal warnings against excessive yen weakness.
As a result, concerns over potential currency intervention are rising rapidly.
Adding to the risk, U.S. markets are closed today for the Juneteenth holiday, reducing overall market liquidity.
Under such conditions, any direct intervention by Japanese authorities could have a larger-than-usual impact.
Long USD/JPY positions therefore require continued caution.
Equity Markets
Equity markets remain resilient.
The combination of easing Middle East tensions and continued capital inflows into AI-related stocks has supported risk sentiment.
However, with the Fed turning more hawkish than expected, investors are beginning to focus on the risk of valuation adjustments caused by higher interest rates.
Key Events to Watch Today
Canada
- April Retail Sales
European Central Bank Speakers
- Philip Lane
- José Luis Escrivá
- Piero Cipollone
- François Villeroy de Galhau
That said, with U.S. markets closed today, overall market activity may remain subdued.
Key Themes Going Forward
- Sustainability of the U.S. dollar rally
- Expansion of expectations for additional Fed tightening
- Continued strength in the U.S. Dollar Index
- Potential move toward 162.00 in USD/JPY
- Timing of possible Japanese currency intervention
- Renewed deterioration in Iran–Israel tensions
- Stability of the temporary Middle East agreement
Conclusion
The market’s primary focus has shifted decisively from:
Middle East geopolitical tensions
to
Federal Reserve monetary policy.
While the temporary agreement between the United States and Iran has reduced immediate geopolitical risks, markets are already looking beyond that development.
At present, the Fed’s increasingly hawkish stance is the dominant force driving the U.S. dollar higher.
USD/JPY has climbed into the 161.00 range, while the U.S. Dollar Index has reached levels not seen since last year.
Nevertheless, the risk of Japanese currency intervention is growing.
While the base-case scenario remains continued dollar strength, traders should remain highly alert to the possibility of sudden yen-buying intervention by Japanese authorities.
