The U.S. dollar edged higher on Tuesday but remained close to multi-month lows against major currencies as investors continued to reassess the outlook for Federal Reserve monetary policy.

Recent U.S. economic data have pointed toward a softer economy, including unexpected job losses and relatively mild inflation readings. As a result, traders have reduced expectations that the Federal Reserve will raise interest rates.

According to CME FedWatch data, markets are now pricing in a 35% probability of a Fed rate increase at the September meeting, down sharply from 52% one week earlier. Traders are also no longer fully pricing in a rate hike by the end of the year.

The dollar index, which measures the U.S. currency against a basket of major peers, was nevertheless up 0.1% at 99.62 as geopolitical concerns provided some safe-haven support.

Euro and Sterling Remain Firm

The euro eased slightly after reaching a two-month high of $1.161 on Monday. It was last little changed around $1.157.

Sterling also remained close to a three-month high, trading around $1.352 after falling 0.1% following weaker-than-expected U.K. labor market data.

The relative strength of the euro and pound reflects, in part, the dollar’s declining interest-rate advantage as investors scale back expectations for further U.S. monetary tightening.

However, the currency market’s reaction contrasts with developments in global bond markets, where investors remain significantly more concerned about the potential inflationary consequences of the Middle East conflict.

Iran Conflict Complicates the Inflation Outlook

The prolonged U.S.-Iran conflict has become a major factor shaping expectations for global inflation and interest rates.

The Strait of Hormuz remains effectively closed, raising concerns about energy supply and transportation. Iran has also indicated that it could shift toward a “fully offensive” military posture as negotiations toward a permanent end to the conflict stall.

The possibility of prolonged disruption has pushed oil prices higher, with Brent crude rising 0.2% to $91.10 a barrel and reaching its highest level since July 30.

Higher energy prices could complicate the Federal Reserve’s policy outlook even if domestic economic growth and employment continue to weaken. Persistent supply-driven inflation would give policymakers less room to ease monetary policy aggressively.

Bond Markets Send a Different Signal

While currency traders have focused on weaker U.S. economic data and falling rate-hike expectations, bond investors have remained more concerned about longer-term inflation and government borrowing.

Long-term borrowing costs across major Western economies reached multi-decade highs on Tuesday. The U.S. 30-year Treasury yield climbed to its highest level since 2007.

Rising Treasury yields are particularly important for the dollar because they can influence international capital flows and the relative attractiveness of U.S. assets. At the same time, higher yields increase financing costs for the U.S. government as Washington continues to meet substantial borrowing requirements.

Recent Treasury auctions have therefore attracted significant attention, with investors demanding elevated yields to absorb the government’s growing financing needs.

Yen Intervention Adds Another Dollar Headwind

The Japanese yen was trading around 159.70 per dollar, having surrendered nearly half of the gains generated by the joint U.S.-Japan intervention at the end of July.

Markets remain focused on the possibility of additional intervention as Japanese authorities attempt to prevent another sharp depreciation toward the yen’s recent 40-year low of 163.99.

Investors are also watching the Bank of Japan’s upcoming meeting, where policymakers are expected to raise interest rates and could consider a more aggressive tightening path afterward.

A stronger yen and greater expectations for Japanese monetary tightening could provide another source of pressure on the dollar.

Market Outlook

The dollar faces competing forces as investors navigate the changing interest-rate and geopolitical landscape. Softer U.S. economic data and declining expectations for Federal Reserve rate hikes are reducing the currency’s yield advantage, while potential intervention by Japan is creating another headwind.

At the same time, the Iran conflict and disruption around the Strait of Hormuz are keeping oil prices and inflation risks elevated. That dynamic is already being reflected in global bond markets, where investors are demanding higher long-term yields despite weaker expectations for near-term rate increases.

The key question for financial markets is whether slowing U.S. economic activity will eventually outweigh the inflationary impact of higher energy prices and persistent fiscal pressures. If inflation remains contained, the dollar could face continued pressure as rate-hike expectations fade. If energy disruptions generate a renewed inflation shock, however, elevated Treasury yields and safe-haven demand could provide the dollar with renewed support.