Dollar bears cling to optimism as war-led inflation tests Fed path: Reuters poll

By Sarupya Ganguly

BENGALURU, June 3 (Reuters) - The U.S. dollar is expected to stay range-bound in the near term before weakening later this year, FX strategists said in a Reuters survey, on optimism the Middle East war will end soon and its impact on inflation will be temporary.

Since the conflict began three months ago, the dollar has tracked risk sentiment - rising on escalation and slipping as tensions eased. An initial short-covering rally has left traders net long, with the dollar up about 2%.

But Brent crude remains more than 35% higher, a surge set to feed through to global inflation. Early signs are visible in the U.S. and euro zone, where inflation has risen to 3.8% and 3.2%, respectively - well above 2% targets.

Treasury yields have climbed sharply and rate futures have priced out pre-war expectations of Federal Reserve rate cuts, now pointing to a prolonged hold - or even a hike - by year-end. Several Fed policymakers have also struck a hawkish tone.

Still, median forecasts in the May 29 to June 3 Reuters poll showed the euro rising about 2% to $1.18 in three months, $1.19 in six and $1.20 in a year, unchanged from May's survey.

"The driver of dollar weakness is a combination of 'risk-on' markets, optimism the conflict in the Middle East is going to end, and optimism that when it ends, we will not see significant or probably any tightening of U.S. monetary policy because the President doesn't want that," said Kit Juckes, chief FX strategist at Societe Generale.

"That, and U.S. policymaking continuing to make global investors nervous about buying U.S. assets, is really what's driving the status quo," he added, predicting any dollar weakness would be temporary.

While U.S. President Donald Trump has called for lower rates, his pick for Fed chair, Kevin Warsh, may face pressure to keep policy tight if the war persists and inflation rises.

The European Central Bank is also expected to raise rates twice this year, a separate poll showed.

DOLLAR BEARS BARELY CLINGING ON

While forecasters have long expected the dollar to weaken, that conviction has wavered in recent months, with a sizeable minority now predicting a smaller decline - or even gains.

Analysts said uncertainty is clouding medium-term forecasts.

"The risks are much more for, at a minimum, a neutral bias, if not a hawkish bias from the Fed. There is a lot of uncertainty surrounding the war, and there are expectations some deal could be imminent, which could alleviate some of the pressure on oil markets," said Alex Cohen, FX strategist at Bank of America.

"But every day this goes on, the risks get greater and greater for higher oil prices and higher global inflation," he added, forecasting some near-term dollar strength.

Asked about dollar positioning by ?end-June, just over half of strategists - 21 of 40 - expected little change. Only two saw a shift back to net shorts, while eight said net long positions would ?increase.

(Other stories from the June Reuters foreign exchange poll)

(Reporting by Sarupya Ganguly. Polling and analysis by Jaiganesh Mahesh. Editing by Mark Potter)