Dollar hovers near four-week peak as markets mull Fed hike odds

By Medha Singh and Satoshi Sugiyama

July 28 (Reuters) - The U.S. dollar steadied near a four-week high on Tuesday as traders assessed the possibility of a Federal Reserve interest rate hike this week, even as falling oil prices offered some relief on the inflation front.

The dollar index, which measures the greenback against a basket of currencies including the yen and the euro, was about flat at 101.50 after touching its highest since July 1. The euro ticked up 0.05% to $1.1370. Against the Japanese yen, the dollar traded at 163.745, while sterling gained 0.1% to $1.330.

The dollar's resilience reflects a sharp repricing of Fed expectations in recent months. Treasury yields have climbed steadily since April as the U.S.-Iran conflict stoked concerns about inflation and a hawkish debut from Fed Chair Kevin Warsh reinforced expectations of higher interest rates.

While oil prices have retreated after the U.S. paused attacks on Iran over the weekend, yields remain near their multi-month highs.

"The move in U.S. yields has been quite powerful in explaining the dollar's moves," said Dominic Bunning, head of G10 FX strategy at Nomura in London.

He said there was a risk that investors have become too convinced of a near-term rate hike, meaning any dovish outcome could force traders to unwind long-dollar positions.

Net long dollar positions were at their highest since 2015 in the latest week, weekly U.S. regulator data showed.

The Fed concludes its two-day policy meeting on Wednesday, with a growing number of major brokerages warning that policymakers could raise rates, given this month's surge in oil prices.

Markets are pricing a nearly 40% chance of a 25-basis-point rate increase on Wednesday, up from about 20% a week ago, according to LSEG data. Traders see almost a 95% probability of a hike by September.

Investors will also look to U.S. second-quarter GDP data and the Fed's preferred inflation gauge, core PCE inflation, this week.

In other major currencies, the Australian dollar weakened 0.3% versus the greenback to $0.697, as Australia's central bank chief Michele Bullock said underlying inflation remained too high and a further slowdown in domestic demand may be required to tame prices. New Zealand's kiwi traded at $0.5772.

PACKED CENTRAL BANK WEEK 

The Bank of England and Bank of Japan are widely expected to keep interest rates unchanged at their meetings on Thursday and Friday, respectively, while maintaining a cautious stance on inflation.

Traders have been on intervention watch for weeks as the yen's unabated slide pushed it to fresh 40-year lows against the dollar at 163.99 last week.

The BOJ is expected to keep the door open to further rate hikes to support the currency, though policymakers are likely to remain vague on the timing and pace of any tightening.

"Can they almost coordinate a little bit whereby the BOJ can deliver a slightly more hawkish message and the (Ministry of Finance) comes in, then you get more bang for your buck, effectively? We saw it in July 2024 .. that was almost the sweet spot for Japan intervention," Bunning said.

"It can be potentially more futile and that's the risk they face."

Tokyo stepped into the market in April and May as the yen breached 160 per dollar, though the moves did little to alter its broader decline.

In a Reuters NEXT Newsmaker interview on Tuesday, Japanese Finance Minister Satsuki Katayama reiterated that Tokyo's stance of responding to currency moves as needed was unchanged, adding that she believed Washington shared that view.

The yen offered little reaction to news of an earthquake with a preliminary magnitude of 7.1 striking Japan's southern Kumamoto prefecture on Tuesday.

In cryptocurrencies, bitcoin fell 2.3% to $63,414.16. Ether declined 3.4% to $1,879.71, the biggest percentage drop in a month.

(Reporting by Medha Singh and Satoshi Sugiyama; Editing by Shri Navaratnam, Stephen Coates, Amanda Cooper and Saumyadeb Chakrabarty)