Dollar Strength Trumps Rate Differential as EUR/USD Hits Two-Week Low

The EUR/USD pair has broken through its two-week low of 1.1580 as the dollar index hits a high near 99.75, fueled by a combination of monetary and geopolitical factors.

Rising bets that the Federal Reserve will hike interest rates on September 16 have increased speculative demand for the dollar, with CME FedWatch odds now at 70%. This comes after Federal Reserve Chairman Kevin Warsh's keynote speech at Jackson Hole, which reset the dollar's trajectory by warning of higher inflation and a need to tighten monetary policy.

The dollar is also being driven up by safe-haven demand due to escalating U.S.-Iran hostilities, with signs of rising Middle East tension boosting risk-averse capital flows into Treasuries. This combination of factors has resulted in broad-based dollar strength, driving the EUR/USD pair lower and leaving it 1.20% down against the dollar year-to-date.

The ECB's September meeting is still expected to deliver a 25-basis-point increase to 2.50%, but the policy gap between the Fed and ECB remains unchanged at 137.5 basis points, suggesting that rate differentials are not currently driving EUR/USD lower.