Dollar firm near 18-month highs, as Gulf unrest, US inflation keep investors on edge

By Amanda Cooper

LONDON, Oct 12 (Reuters) - The dollar traded around its highest in a year and a half on Monday, as an escalating Middle East conflict kept investors wary ahead of key US inflation data later this week that could shape the outlook for interest rates.

Oil prices were volatile after Yemen's Iran-backed Houthis stepped up strikes on Saudi Arabia, while two tankers were attacked over the weekend. 

Brent crude futures were down 0.5% at $104 a barrel, under a touch of pressure after Sunday's announcement from US President Donald Trump about an energy ceasefire between Ukraine and Russia. The futures price is still nearly 45% above where it was before the war started, while prices on some physical markets are double those levels.

The dollar index, which tracks the US currency against six others, was slightly down at 102.16 but remained within sight of last week's 18-month highs.

Weekly data from the US markets regulator shows investors have been adding to their bullish positions in the dollar, which rose to around $36 billion in the week to October 7, from just $8.4 billion three weeks ago, largely at the expense of the euro.

"The US dollar has strengthened recently on the back of negative developments overseas that have boosted its appeal even as market participants have pared back expectations for Fed rate hikes," MUFG currency strategist Lee Hardman said.

SPOTLIGHT MOVES TO US INFLATION DATA 

Wednesday's US consumer inflation report, one of the last major economic releases before the Federal Reserve's policy meeting this month, could be critical in determining the near-term direction of the dollar. 

Data last week showed US consumer sentiment deteriorated further in early October, as the rising cost of living because of the Middle East conflict soured households' views of the economy.

The Fed raised rates last month for the first time since 2023 to rein in inflation, with markets keeping a close watch on economic data to gauge whether policymakers may move again. Traders are pricing in an 81% chance of the Fed standing pat this month, up from 51% a month earlier, the CME FedWatch tool showed.

"It's a very high bar for the Fed to raise rates in October," said Chris Weston, head of research at Pepperstone. "But if we do see a hot number, the question becomes whether they could go again in January — hiking in December and then potentially again in January, as opposed to the market's view that they go again in March."

Severe selloffs in bond markets in the past few weeks had left investors worried as borrowing costs across the globe rose to multi-decade highs on worries over inflation, energy prices and ballooning government debt. 

The euro was steady at $1.12, after clocking a fifth straight week of losses as the common currency bore the brunt of investor angst around France's fiscal health amid political uncertainty before the 2027 presidential election. The spread between French 10-year yields and relatively safe German yields nudged out to 138 basis points, near its highest since 2012.

"It is still too early to tell whether higher borrowing costs will be sufficient to impose greater fiscal discipline on the French government," said OCBC FX strategists. 

Against the yen, the US dollar was flat at 158.41 yen in holiday-thinned trading in Japan, while the pound edged up 0.1% to $1.3244.

The Indian rupee climbed 1.1% to 95.7 against the dollar after the central bank moved to alleviate pressure on the currency by diverting oil companies’ dollar purchases away from the spot market. 

(Additional reporting by Li Gu in Shanghai and Ankur Banerjee in SingaporeEditing by Muralikumar Anantharaman and Peter Graff)