By Stefano Rebaudo
Oct 13 (Reuters) - The dollar slipped from 18-month highs on Tuesday in line with a retreat in oil prices with investors hoping the Middle East conflict would remain contained ahead of US midterm elections and shifting focus to the Federal Reserve's rate path.
Markets expect US President Donald Trump to avoid escalation in the Middle East and Ukraine, as wider conflict could hurt his standing ahead of the midterm elections.
Trump said last week the US will not attack Iran before the elections,
and mentioned an energy ceasefire between Russia and Ukraine on Sunday.
Oil prices fell on Tuesday and were on track for their first decline in nearly a week as traders weighed the prospect of additional diesel supplies from Russia.
Wednesday's September consumer price index reading should provide further clues about possible Fed tightening.
Traders see an 80% chance of the Fed leaving rates unchanged this month, up from 51% a month ago, while pricing in about 75 basis points of tightening by late 2027, CME's FedWatch Tool showed.
“While markets would react to a hawkish surprise, one CPI release may not be enough to undo a pause narrative that senior officials have seemed keen to establish,” Daragh Maher, senior forex strategist at HSBC, said.
A modest upside surprise in inflation data may strengthen confidence in December's already-priced hike without changing October or the dollar materially.
Investors abandoned bets on a Fed rate hike later this month after two policymakers argued for gathering more evidence before deciding whether further tightening is needed, while Governor Christopher Waller said inflation expectations remained "well anchored"
The US dollar index, a measure of the greenback's strength against a basket of six currencies, slid 0.30% to 102.26 after reaching 102.61 on Monday, its highest since April 2025.
Rising oil prices usually support the dollar at the expense of energy-importing currencies such as the euro and yen.
Some analysts raised doubts about the dollar valuations based on the rate outlook. Societe Generale strategist Kit Juckes argued that, if the US rate story is getting stretched, selling euro/yen offered better risk-reward than selling the euro against the greenback.
EURO REBOUNDS DESPITE GAS PRICES HITTING HIGHS
The euro rebounded from a roughly 17‑month low on Tuesday despite another jump in gas prices, a key driver of euro zone inflation, while concerns over France's fiscal outlook persisted. It was up 0.32% at $1.1190 after hitting $1.11525 on Monday, its lowest since May 2025.
"The prospect for good news coming in the euro area is slim, and any further bad news would prompt the ECB to slow the pace of rate hikes, or end them altogether," Thierry Wizman, global forex and rates strategist at Macquarie Group, said, referring to France’s fiscal trajectory and the impact of the energy shock.
The ECB slowing the pace of rate hikes "would likely cause further euro/dollar downside", he added.
Natural gas prices reached €86.30, their highest level since December 2022.
The yen strengthened 0.36% to 158.04 against the dollar after Bank of Japan data showed wholesale prices rose 6.8% in the year to September, missing a median market forecast of 7.6% but still enough to justify market fears of higher interest rates.
Investors continued to see support from the prospect of further BoJ policy tightening, and the risk of official intervention against excessive currency moves.
MUFG recently recommended a short euro/yen trade idea to reflect building downside risks for the single currency from heightened fiscal and political risks in the euro area.
The euro was down 0.1% at 176.81 versus the Japanese currency, after hitting 176.25, the lowest level since November 2025.
The Australian dollar was at $0.6975, little changed after the release of minutes from the Reserve Bank of Australia's September board meeting that voted unanimously to raise rates for the fourth time this year.
(Reporting by Stefano Rebaudo; Editing by Clarence Fernandez and Jan Harvey)
