The US dollar is on track to post its strongest monthly gains in nearly a year, supported by safe-haven demand as the war in the Middle East escalates and hopes for de-escalation fade.

Market movements have been driven by heightened tensions following another volatile week, especially after US President Donald Trump once again extended the deadline for targeting Iranian energy facilities, while Washington and Tehran offered conflicting accounts regarding diplomatic progress.

The US Department of Defense is also considering sending up to 10,000 additional troops to the region, according to The Wall Street Journal, further dampening investor optimism about a near-term end to the war.

Dollar benefits from safe-haven flows

Safe-haven inflows have supported the dollar, alongside rising expectations for US interest rate hikes this year. The dollar index traded near the 100 level, up about 2.4% since the start of March, on track for its best monthly performance since July 2025, when it gained 3.4%.

Yen under pressure and potential intervention test

The Japanese yen weakened toward the 160 per dollar level, a threshold traders view as a potential trigger for official intervention. The yen was last trading at 159.86 after touching 159.98 earlier.

Lee Hardman, a currency strategist at MUFG, said the market will test the authorities commitment, noting that officials have repeatedly signaled in recent weeks their readiness to take strong action, and that levels are now approaching a point that could prompt actual intervention.

The yen has also come under additional pressure from rising Japanese bond yields after the Bank of Japan released new estimates for the neutral interest rate, indicating policymakers willingness to raise rates to address inflation. Japans heavy reliance on energy imports also makes it more vulnerable to rising prices compared to other major economies.

Euro and sterling decline

The euro fell 0.1% to $1.152, while the British pound declined for the fourth consecutive session, down 0.2% to $1.331.

Carol Kong, a currency strategist at Commonwealth Bank of Australia, said the conflict does not appear likely to end soon, adding that the US dollar remains dominant as long as the conflict continues.

She added that if the conflict proves prolonged, oil prices are likely to continue rising, which would support the dollar at the expense of energy-importing currencies such as the yen and the euro.

Risk-sensitive currencies under pressure

The Australian dollar, which is sensitive to risk sentiment, fell to a two-month low before recovering to trade at $0.688, having lost about 2% since the start of the war, making it the second worst-performing currency after the Indian rupee, which declined around 3%.

Rising rate expectations and higher yields

Investors are now pricing in around a 70% probability of a quarter-point US rate hike this year, according to the CME FedWatch tool, marking a sharp shift from earlier expectations of more than 50 basis points in cuts before the outbreak of the war.

The Bank of England and the European Central Bank are also expected to tighten monetary policy, as part of a broader shift in interest rate expectations, which has pushed bond prices lower and yields to multi-year highs during the current month.

US Treasury yields rose slightly on Friday following a strong overnight jump, with the two-year yield at 3.9899%, while the benchmark 10-year yield increased by about one basis point to 4.4278%.