Dollar regains strength - but only by default: Mike Dolan

Analysis by Mike Dolan

Following the recent attacks involving Iran, there’s a renewed perception that the U.S. dollar is regaining its reputation as a safe haven. However, the reality is more nuanced, with the dollar’s strength being driven largely by shifts in global energy markets rather than a straightforward rush to safety. The consequences of this market reaction could be significant.

Since Donald Trump’s return to the presidency last year, the dollar has often weakened even during periods of heightened market stress and uncertainty. This trend is largely attributed to unpredictable U.S. economic policies and ongoing political turbulence both within the country and abroad.

A central goal of the Trump administration has been to address the dollar’s long-standing overvaluation. Yet, the currency’s reduced role as a global refuge during times of crisis suggests that international investors—already heavily invested in U.S. assets—are changing their approach.

That’s why it was notable to see the dollar surge broadly after the recent joint bombing campaign by U.S. and Israeli forces targeting Iran, including the assassination of Supreme Leader Ali Khamenei and the subsequent escalation of regional violence.

This upward move in the dollar was less about investors seeking safety and more about the impact of rising energy prices. Essentially, investors shifted away from currencies belonging to countries most vulnerable to prolonged spikes in energy costs.

Energy Markets Drive Currency Moves

With the United States now exporting more petroleum and energy products than it imports, the initial 10% jump in global oil prices on Monday had a much harsher effect on other major currencies. Concerns grew that a sustained supply disruption could severely impact demand for weeks or even months.

Traditional safe-haven currencies like the Japanese yen failed to attract support this time. The yen fell over 1% against the dollar on Monday, reflecting Japan’s heavy reliance on energy imports—about a third of which pass through the Strait of Hormuz.

China, another major oil consumer, also felt the impact. Its access to discounted Iranian crude—already sanctioned by the West and now at risk—was jeopardized, causing the yuan to drop 0.8% as events unfolded.

“This situation is unfavorable for Northern Asian currencies,” observed Kit Juckes, a currency strategist at Societe Generale. He also noted that Trump’s statements suggest the U.S. military response could last for weeks rather than days.

Europe faces its own challenges, particularly due to its dependence on natural gas. The closure of the Hormuz shipping route—responsible for 20% of global liquefied natural gas and up to 30% of crude oil shipments—has further complicated the outlook.

European Energy Shock

On Monday, benchmark European gas prices soared by nearly 50% at one point, reaching their highest level in over a year before closing up 35%. This prompted the European Union’s gas supply group to call an emergency meeting for Wednesday.

Last year, the U.S. supplied 58% of the EU’s liquefied natural gas imports. Qatar, which provided 6%, halted production on Monday following Iranian attacks.

The euro fell 1% against the dollar, reaching its lowest point in over a month.

The Swiss franc continues to serve as a traditional safe haven, but its role is complicated by the Swiss National Bank’s ongoing efforts to combat deflation and its renewed commitment to intervene in currency markets to prevent the franc from appreciating too much.

Assessing the Global Economic Impact

Barclays economists estimate that every sustained $10 increase in crude oil prices could shave up to 0.2 percentage points off global economic growth. If predictions of oil surpassing $100 per barrel come true, the impact could be substantial.

So far, however, Brent crude’s net increase of $5 to $77 per barrel on Monday represents a relatively modest blow, with little expected effect on U.S. demand.

Attention now turns to whether higher oil prices will slow economic growth or fuel inflation. With U.S. core inflation already above 3%, there may be more reason to keep interest rates elevated—another factor supporting the dollar.

As is often the case with Middle East conflicts, the ultimate economic fallout depends on how long the hostilities and energy supply disruptions last.

Trump has suggested that the military campaign could continue for four to five weeks. Prediction markets like Polymarket currently estimate a 63% chance that he will call an end to the operation by month’s end.

Most currency market reactions, however, appear to be based less on a scramble for dollars and more on relative assessments of how exposed different economies are to energy shocks.

Nevertheless, these dynamics can create a powerful feedback loop.

Barclays’ rule of thumb suggests the dollar typically rises between 0.5% and 1.0% for every $10 increase in oil prices.

If energy prices denominated in dollars continue to climb and remain elevated, this could further strengthen the dollar, intensifying the energy shock for other economies and creating a self-reinforcing cycle.

Such a scenario would be undesirable for all parties involved, especially for policymakers in Washington.

The views expressed are those of the author, a Reuters columnist.