FOREX: Dollar wavers amid Middle East tensions

The U.S. dollar hovered near a one-week high on Tuesday, with markets torn between conflicting Middle East signals, as hostilities in the region stoked renewed fears over energy supplies while hopes for a ceasefire offered some relief.

Against the yen, the dollar was largely flat at 162.49 yen. The euro was little changed at $1.1417, while the British pound was roughly 0.1% firmer at $1.3441 after Britain's new Prime Minister Andy Burnham vowed to stick to fiscal rules.

The U.S. dollar index, which measures the currency against a basket of six peers, was steady at 100.93, after touching its highest level since July 15 in previous session.

Markets remained hostage to Middle East tensions, with oil prices seeing a sharp swing to near six-week highs before retreating. Yemen's Iran-aligned Houthis declared a naval blockade on Saudi Arabia, raising threats to global energy supplies, while hopes of de-escalation persisted after Tehran received a 10-day ceasefire proposal from mediators.

"There is the hope for easing in a little bit of tensions and we'll hit a pause button at some stage. It's all still very volatile," Rodrigo Catril, senior currency strategist at National Australia Bank, said in a podcast.

"We have to wait and see how it develops. We need to see whether this escalates."

INFLATION RISKS LOOM LARGE

U.S. Treasury yields crept back up as traders weighed whether a renewed jump in oil prices, driven by the widening war with Iran, would eventually feed through to consumer prices.

The benchmark 10-year Treasury yield remained elevated at 4.5938%, while yields on 30-year Treasuries were firmly above the 5% mark.

Recent reports on U.S. inflation and labor market conditions have caused markets to sharply curb expectations for a Federal Reserve rate hike next week, with the implied probability now at just 17%. However, chances of a hike at the September meeting have risen to 63%, according to CME FedWatch.

A European Central Bank survey showed on Monday that euro zone firms expect selling prices to rise more moderately. The ECB is expected to keep rates unchanged this week but high oil prices are fuelling bets for another hike in the 2.25% deposit rate in September.

Japan's benchmark bond yields also rose sharply on Tuesday as war-linked inflation pressures mount, with investors now looking ahead to the Bank of Japan's meeting next week to see if there will be any suggestion of an acceleration in the pace of rate hikes.

"The combination of higher crude and refined product prices, if sustained, will add to pressure on goods inflation and create the risk of larger policy rate increases than we already forecast," analysts at Eastspring Investments said in a note.

The New Zealand dollar was 0.4% stronger at $0.5864, hitting its highest level since early June, after strong inflation data reinforced expectations of further rate hikes. The Australian dollar was a touch stronger at $0.7001.

Elsewhere, the Canadian dollar CAD=D3 steadied after dropping to a one-month low, after the United States imposed a new tariff of 50% on a wide range of Canadian products in response to what it called Ottawa's "discriminatory treatment".

-Reporting by Jiaxing Li in Hong Kong; Editing by Shri Navaratnam and Lincoln Feast./Reuters