The U.S. dollar headed toward its first weekly gain in a month on Thursday as tensions between Iran and the United States escalated amid the conflict in the Middle East. Stalled peace talks pushed oil prices back above $100 per barrel, dampening investor optimism.

Tehran heightened the standoff by seizing two ships in the Strait of Hormuz on Wednesday. This followed President Donald Trumps decision to extend the ceasefire with Iran indefinitely without any clear signs that peace negotiations would resume.

The two sides remain deadlocked over the ceasefire terms, mutual blockades, the nuclear file, and control of the Strait. This has kept the strategic waterway nearly closed, triggering a shock in energy markets that continues to weigh on the global economy.

Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets, noted that the "path of least resistance at the moment is a slight increase in dollar holdings, as the peace premium that had returned to markets fades."

Currency Performance

- The Euro fell below $1.17, touching its lowest level since April 13 earlier in the day. It is on track for a weekly decline of 0.7%, its first drop in four weeks.

- The British pound slipped 0.1% to $1.3488, disregarding data showing that consumers in Britain have already begun cutting fuel spending due to the early effects of the conflict involving the U.S. and Israel against Iran.

- The Japanese yen weakened slightly to 159.73 per dollar, nearing the 160 levela threshold many market participants view as a potential trigger for official intervention. The Bank of Japan is expected to hold interest rates steady next week while signaling a possible hike in June.

Dollar Index and Market Sentiment

The U.S. dollar index, which tracks the currency against six major rivals, rose 0.17% to 98.78 points. It is set for a weekly gain of approximately 0.4%, its first in a month.

While the dollar benefited significantly from the initial volatility when the war broke out in March, hopes for a peace deal earlier this month had pushed investors toward higher-risk currencies, erasing much of those gains. However, the nearly two-month-old conflict has caused a sharp spike in fuel prices and a decline in consumer confidence, effectively eliminating expectations for interest rate cuts this year.

Regional Financial Developments

On Tuesday, President Trump mentioned that a currency swap agreement with the United Arab Emirates is under consideration. This followed a Wall Street Journal report stating that the Governor of the UAE Central Bank proposed the idea to the U.S. Treasury Secretary and Federal Reserve officials in Washington last week.

"In times of instability, questions arise regarding access to financing and liquidity," Stretch added. "These countries are also affected by declining revenue flows, making these precautionary measures justified."

Interest Rate Outlook

Markets currently show that traders see only a 25% chance of a Federal Reserve rate cut this year, while two rate hikes from the European Central Bank are being priced in for 2026.

Michael Brown, market strategist at Pepperstone, commented: "My view remains that the U.S. economy is the most capable of withstanding this shock, especially if other central banks, like the ECB, decide to proceed with monetary tightening." He added that any dip in the dollar remains a buying opportunity, particularly as the index hesitates to drop below the 98 level.

Investors are now turning their attention to weekly U.S. jobless claims and Purchasing Managers' Index (PMI) data due later on Thursday to gauge whether rising energy costs are beginning to impact the broader economy.