Dollar drops on Middle East optimism, euro highest since 2021

By Karen Brettell

NEW YORK (Reuters) -The dollar fell on Tuesday and the euro rose to its highest level since October 2021 after a ceasefire between Iran and Israel was announced, even as Federal Reserve Chair Jerome Powell repeated that he expects inflation to begin rising this summer.

The ceasefire began to take hold on Tuesday under pressure from U.S. President Donald Trump, raising hopes for an end to the biggest ever military confrontation between the Middle East arch-foes.

"The market right now is unwinding the Middle East trade," said Adam Button, chief currency analyst at ForexLive in Toronto.

The euro and yen gained as oil prices tumbled. The European Union and Japan rely heavily on imports of oil and liquefied natural gas, while the U.S. is a net exporter.

The single currency was last up 0.38% at $1.162 after earlier reaching $1.1641. The dollar weakened 1% to 144.68 Japanese yen.

Risk sensitive assets including the Australian dollar also gained on improving risk sentiment. The Aussie was last up 0.68% versus the greenback at $0.6503.

Sterling rose 0.77% to $1.3626 and reached $1.3648, the highest since January 2022.

The U.S. currency fell even after Powell said in testimony before U.S. Congress that he and many at the Fed expect inflation to start rising soon, and that the central bank was in no rush to ease borrowing costs in the meantime.

Traders were particularly attuned to his remarks after two other Fed policymakers indicated they support near-term rate cuts, citing concerns over the labor market and falling expectations about a resurgence in inflation.

"The market was looking for a strong pushback regarding the possibility of a rate cut but Powell continues to sit on the fence," said Button.

"The big debate at the Fed right now is in the jobs market. Waller and Bowman are saying they're seeing signs of softness, whereas Powell said we don't see weakness in the labor market," Button said.

Fed Vice Chair for Supervision Michelle Bowman said Monday the time to cut interest rates appears imminent while Fed Governor Christopher Waller on Friday that the Fed should consider cutting interest rates at its next meeting.

U.S. President Donald Trump said on Tuesday that interest rates in the country should be lowered by at least two to three percentage points.

Fed funds futures traders are pricing in 60 basis points of cuts this year, up from around 46 basis points before Waller's comments on Friday. That indicates expectations that two 25-basis-points in cuts are certain, with a rising chance of a third reduction. 

A cut at the Fed's July 29-30 meeting continues to be seen as very unlikely, with the first cut expected in September.

If the economy deteriorates and the Fed cuts interest rates faster than currently expected that could be very negative for the dollar, said Vassili Serebriakov, an FX strategist at UBS in New York.

However, "if it doesn't, if the Fed doesn't cut until September and then delivers just two cuts this year, we're probably looking at some dollar weakness, but it's unlikely to be very significant, especially for pairs like dollar/yen, because the dollar still just benefits from carry quite a bit."

Data on Tuesday showed that U.S. consumer confidence unexpectedly deteriorated in June as households worried about business conditions and employment prospects over the next six months.

In cryptocurrencies, bitcoin gained 1.72% to $105,589.

(Reporting by Karen Brettell; Additional reporting by Stefano Rebaudo, editing by Deepa Babington)