Dollar holds firm as Iran tensions rattle markets, yen stuck near 40-year low

The US dollar stabilised on Thursday, supported by renewed tensions between Washington and Tehran that kept investors cautious and fuelled demand for safe-haven assets. The yen, meanwhile, languished near a 40-year low, with little sign of a turnaround despite verbal warnings from Tokyo.

The dollar index, which measures the greenback against a basket of major currencies including the yen and the euro, was flat at 101.11. The greenback has strengthened as the escalating conflict between the US and Iran triggered a rebound in oil prices and fanned inflation fears. Brent crude futures rose more than 1.3 per cent to $95.31 a barrel on Thursday, after the US military launched a new round of strikes on Iran and the Iranian-aligned Houthis claimed military strikes on two Saudi oil tankers, raising the risk of further disruption to Red Sea oil flows.

Two-year US Treasury yields climbed to a 17-month high on Wednesday, as rising oil prices stoked inflation concerns that could increase the odds of Federal Reserve interest rate hikes. 'What is different from the start of the conflict five months ago is inventories. Lower inventories mean shortages of oil and gas are more likely the longer the conflict continues, exacerbating the negative economic impact of high energy prices which favours the USD,' said Joseph Capurso, head of international economics and foreign exchange at Commonwealth Bank of Australia, in a note.

The euro was up 0.02 per cent at $1.1412. The European Central Bank will hold a meeting later on Thursday. It is all but certain to keep interest rates unchanged but will hold the door wide open to another rate hike in September, as a fresh jump in energy prices threatens to put more upward pressure on inflation.

The Australian dollar dipped 0.1 per cent versus the greenback to $0.6989, while New Zealand's kiwi softened almost 0.1 per cent to $0.5811. British sterling last traded at $1.3373.

Why is the yen still so weak?

The Japanese yen edged 0.02 per cent higher against the greenback to 163.1 per dollar, surrendering gains after Bloomberg News reported on Wednesday that Bank of Japan officials were open to raising rates at a faster pace than the consensus among economists. Reuters reported that the BOJ remains on alert to upside inflation risks that could lead to faster interest rate hikes than markets project, according to three sources familiar with its thinking.

The currency weakened to 163.23 on Tuesday, its lowest level since December 1986, as investors adjusted to a shifting policy backdrop under Japanese Prime Minister Sanae Takaichi. Her administration has struggled to dispel expectations that it could pressure the BOJ to delay further rate hikes. Japan's finance minister has repeatedly issued verbal warnings about possible intervention in the currency market, and Tokyo carried out yen-buying operations in April and May.

But the yen's broader trajectory has remained unchanged. Analysts attribute its weakness to broad-based dollar strength and the BOJ's still-low interest rates. 'Against the backdrop of rising energy prices and mounting expectations of a more hawkish Fed meeting next week, it appears very unlikely -- despite continued threats -- that Japanese authorities will intervene until after next week's FOMC meeting,' said Tony Sycamore, market analyst at IG Australia, in a note.

What does this mean for Southeast Asian markets?

For ASEAN economies, the sustained dollar strength and elevated oil prices present a dual challenge. Higher energy costs directly impact import-dependent nations like Singapore and Thailand, while a strong greenback pressures regional currencies and complicates monetary policy decisions. The Bank of Thailand and Bank Indonesia, for instance, may face renewed pressure to hike rates to defend their currencies, potentially slowing domestic growth. Meanwhile, Singapore's MAS, which manages the Singapore dollar against a basket of currencies, may need to maintain its appreciation stance to counter imported inflation. The situation underscores the interconnectedness of global geopolitics and regional financial stability, a theme that will dominate discussions at the upcoming ASEAN Finance Ministers' Meeting in Jakarta.