The ongoing conflict in the Middle East has led to a notable increase in oil prices, which in turn has supported gains in the US Dollar (USD) as investors seek safe-haven assets and price in a 'conflict premium' [1][3][5]. ING's Chris Turner highlights that the Dollar Index (DXY) is testing the top of its nine-month range near 100.35/40, with markets awaiting central bank responses, particularly the Federal Reserve's (FOMC) meeting this week [1]. Turner expects the FOMC event to be Dollar-positive, as the Fed is likely to push back against current market expectations for rate cuts, especially with inflation risks potentially rising to 3.5% this summer due to elevated energy prices [1].
HSBC concurs that the USD has benefited from safe-haven demand and short covering, but notes that the current environment lacks the 2022-style drivers of a structurally stronger Dollar, such as a clearly hawkish Fed and weak global growth. HSBC expects that a de-escalation in geopolitical tensions could see the USD resume softening, unless the conflict prompts a sharp repricing of Fed expectations towards further tightening [3]. However, if the conflict persists and energy prices remain high, the USD could remain supported, especially as the US is less exposed to energy shocks compared to other economies [3].
The Euro (EUR) has come under pressure, with EUR/USD falling 4% to 1.1415 in early March, primarily due to the geopolitical premium and flight to safety into the USD [2]. DBS notes that unless the European Central Bank (ECB) pushes back against market pricing for two rate hikes in June and September, EUR/USD is expected to find support near 1.1390 [2]. ING adds that EUR/USD has found support at last summer's low near 1.1390/1.1400 after a sharp 3% decline, but warns that elevated oil prices and heavy net Euro long positioning still pose downside risks. ING expects EUR/USD to move higher in the coming months once oil flows normalize, but cautions that another energy spike could push the pair toward the 1.12/1.13 area [4]. ECB President Christine Lagarde has reiterated the commitment to prevent a repeat of the 2022-23 inflation spiral [2].
In the commodity-linked currency space, the Canadian Dollar (CAD) has started to benefit from higher oil prices, but Commerzbank's Michael Pfister notes that structural headwinds and close linkage to the USD limit further outperformance. A sustained oil price above $100 could improve Canada's real rate differential versus Europe, but Commerzbank remains cautious and maintains its USD/CAD forecast at 1.37 for the first half of the year [5].
CONCLUSION
The Middle East conflict has driven a surge in oil prices, supporting the US Dollar and pressuring the Euro, with central bank policy responses in focus. While the USD remains buoyed by safe-haven flows and inflation concerns, a de-escalation in tensions could reverse some of these gains. Market participants are closely watching upcoming central bank meetings and energy market developments for further direction.