The US dollar index slipped again during Friday's Asian trading session after a brief overnight rebound, trading near 98.70 and hovering close to its lowest level since mid-May. The cooling expectations for Federal Reserve rate hikes remain the primary drag on the greenback, though geopolitical risks and inflationary pressures are providing some underlying support.

Ebbing rate-hike bets weigh on the dollar, yet geopolitical risks offer a floor. Last week's moderate US inflation data prompted investors to trim their wagers on a September rate increase from the Fed. However, geopolitical risk is adding a layer of support beneath the currency, as President Trump vowed to impose the "harshest economic actions" on Iran and threatened severe consequences for any nation helping Tehran evade sanctions. This stance keeps a geopolitical risk premium in play, likely deterring traders from aggressively betting against the safe-haven dollar.

Meanwhile, the CME FedWatch tool indicates investors still price in roughly a 68% probability of at least one rate hike before year-end, a scenario that continues to underpin elevated US Treasury yields and should limit further downside for the dollar index. In this context, the near-term downside room for the dollar may be constrained.

Inflation risks are resurfacing as the impact of buyback news fades and yields reclaim attention. The market's initial boost from the Treasury's announcement to double the size of certain long-dated bond buybacks quickly dissipated. Energy prices climbed amid escalating US-Iran tensions, with crude oil touching a three-week high on Thursday, pushing inflation risk back into the spotlight. Against this backdrop, Treasury yields remain elevated, offering solid support for the dollar. Although the probability of a September hike has dropped significantly, year-end expectations still hover near 68%, suggesting the market has not fully ruled out further tightening. With persistent inflation risks and elevated geopolitical uncertainty, dollar bears need to tread carefully.

Institutional outlooks diverge

Analysts at Citi's currency strategy team project the dollar index will decline to around 98.30 over the next three months. Their key rationale centers on the market positioning for a softening of the Fed's hawkish stance, the upcoming US midterm elections, and the Treasury's expanded long-dated bond buybacks. The strategists noted that Bessent's buyback measures, aimed at lowering long-end borrowing costs, could come at the expense of a weaker dollar. Over recent months, the team has shifted its dollar stance to "more neutral" and cautioned that downside risks may increase in the months ahead. Citi believes that fiscal-driven liquidity changes are steering the dollar narrative from a rate-hike cycle toward a depreciation track.

HSBC, in its latest foreign exchange outlook, argues that despite the dollar's recent weakness from yen intervention risks and Fed policy uncertainty, the currency is poised to regain its upward trajectory, supported by robust US economic growth and favorable interest rate differentials. HSBC does not anticipate a rapid or sharp appreciation of the dollar but sees room for gradual gains over the medium to long term given the still-significant rate gaps. However, ahead of the Fed's September policy meeting, key economic data releases are likely to make dollar movements choppy.

In summary, the dollar index is hovering near three-month lows, with fading Fed rate-hike expectations serving as the core headwind, while geopolitical risks and inflation pressures provide a floor. The impact of the Treasury's expanded buyback announcement quickly faded, and Trump's "harshest economic actions" rhetoric against Iran pushed energy prices higher, reigniting inflation concerns. The roughly 68% probability of at least one rate hike by year-end continues to support elevated Treasury yields, limiting further downside for the dollar. With inflation risks and geopolitical uncertainty intertwined, dollar bears should remain cautious.

As of 11:07 Beijing time on August 21, the dollar index stood at 98.72.