How is the Middle East conflict impacting the FX market?
The desk posits that the recent escalation in the Middle East conflict has led to a notable rebound in the USD, driven by historical patterns of currency performance during energy price shocks. Per the full note from MUFG EMEA, the USD's strength can be attributed to its safe-haven status amid geopolitical tensions, which typically results in increased demand for the currency. This aligns with historical data showing that the USD often appreciates during periods of heightened energy prices and market uncertainty, as investors seek stability. The desk's view is supported by the current market dynamics, where the USD index has shown resilience, reflecting a flight to safety in the face of rising geopolitical risks.
What the desk is arguing
The current Middle East conflict has provided a fresh impetus for USD gains, reflecting a historical trend where geopolitical tensions negatively impact risk sentiment and elevate demand for safe-haven currencies. Investors are often drawn to the USD in times of crisis, viewing it as a robust hedge against instability and potential supply shocks in the oil market.
Supporting this view, energy price fluctuations typically correlate with USD performance, especially during conflicts in oil-producing regions. The recent rise in crude prices amplifies this dynamic, which highlights the dollar's strength against a backdrop of uncertainty. Such scenarios historically lead to a flight to quality, reinforcing the dollar's role as a primary safe asset.
Where it sits in our coverage
In our current coverage, the consensus target for the USD is 1.075, with a range from 1.04 to 1.12. This aligns well with MUFG’s observations on how the USD typically strengthens during geopolitical crises. The view indicates a bullish perspective, factoring in a consensus on continued demand for safe-haven assets amid global instability.
Specific targets from peer firms include: - Barclays: 1.10, as of Dec-26 - JPMorgan: 1.10, as of Dec-26 - Goldman Sachs: 1.12, as of Dec-26
How other firms see it
The insights from Bank of America suggest a more cautious approach, reflecting a contrary stance on USD strength amid the turmoil. They have set a lower target of 1.04, emphasizing potential market corrections that could diminish safe-haven flows.
Other firms with aligned views include: - Goldman Sachs: bullish on the USD amid geopolitical tensions - Barclays: reinforcing a favorable outlook for the dollar based on historical performance during energy price shocks
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01USD gains reflect historical trends during geopolitical tensions
- 02Increased crude prices align with dollar strength as safe haven
- 03Mixed views among firms indicate divergence in target strategies
Market implications
The current geopolitical crisis is likely to maintain volatility in the FX market, with the USD expected to remain a favored asset for risk-averse investors. Continued fluctuations in energy prices will further influence dollar valuations, potentially reinforcing bullish positions.
Risks to this view
Potential de-escalation in Middle East tensions could reverse current trends and lead to a weakening of the USD if risk appetite returns to markets. Furthermore, significant market corrections could emerge if energy price shocks do not manifest as anticipated.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday 6th March 2026 and joining Lee to pose some questions on the financial market themes for the week ahead is Abdul Ahad Lockhart, Currency Analyst at MUFG. This material is only intended for professional investors in jurisdictions in which its use is permitted under applicable laws, rules and regulations.
It has been produced for information purposes only and should not be construed as investment research or advice. MUFG EMEA disclaimers and disclosures can be located on our website. Hi Lee.
Hi Abdul Ahad. So it's been a volatile week for financial markets triggered by the conflict in the Middle East. How have developments impacted the FX market?
Yeah, like you said, it's been a very volatile week in markets. Obviously, the main spillover channel from the Middle East developments into the FX market has been through the price of energy. We've seen the price of oil jump by almost 30% over the past week and natural gas price as well in Europe has jumped by an even bigger amount, by 70%.
So this is clearly having more of an impact now in terms of FX performance. It certainly helped the dollar to rebound after a weak start to this year. There are a couple of reasons why we think the dollar benefits from higher energy prices.
One, the US economy now is a net exporter of energy, whereas European and Asian economies are bigger importers of energy. That means that when energy prices jump, that has more of a negative impact on European and Asian economies, helping to boost the appeal of the US dollar. Secondly, the higher energy prices has also prompted the US rate market to scale back expectations for further rate cuts from the Fed at the start of this year, which has been putting some upward pressure on short term US yields and the dollar.
Finally, on top of that as well, we've also had the positioning angle, which, as we said, most people, including ourselves, had been bearish on the dollar at the start of this year in anticipation of further weakness. This rebound for the dollar over the past week has certainly triggered a squeeze of those short dollar positions. The leverage fund positioning did indicate that short dollar positions had reached the highest level since back in early 2022.
I think when you put all of those factors together, it does make sense that the dollar has staged quite a strong rebound this week, although we would still say it hasn't really broken out of recent established ranges. The dollar index is still in the 96 to 100 range, where it's been since the second quarter of last year, but there is obviously an increasing risk that if oil prices and energy prices continue to surge higher in the weeks ahead, we could as well see the dollar as well stage an even bigger, bigger rebound. I know, Abdullah, you've also been looking into the performance of FX during prior oil price shocks.
It'll be interesting to hear your findings from your studies. Yeah, thanks, Lee. So this week, against the backdrop of the ongoing conflict in the Middle East, we examined how G10 FX historically responded to sharp oil moves, and how this relationship has structurally changed since the beginning of the US shale industry.
So our framework assumes a simple linear relationship, estimating an oil beta for each G10 currency. This allows us to quantify how much currency typically moves in percentage terms when oil moves by a given amount. So a key element of the analysis is recognizing the US regime shift, this difference between pre-shale and post-shale errors.
So the shale revolution refers to the rapid rise in US oil and gas production enabled by horizontal drilling and hydraulic fracking. Pre-shale, 1999 to 2011, was a period in which the US remained a declining oil producer, heavily reliant on imports. Oil shocks in this era were largely interpreted as global demand impulses, typically associated with risks on behavior.
Correspondingly, in our results, we observe commodity and high beta effects, tending to appreciate during large oil upbeats. So during the post-shale, 2020 to 2012 to present, this era marked US transition into a major marginal supplier of crude oil. As US shale output ramped up, the nature of oil shocks shifted.
They increasingly reflected supply dynamics, geopolitical disruptions, and inflationary pressure. Rather than pure global demand, this made oil spikes more dollar supportive and far less reliably positive for commodity effects. This regime shift underpins the collapse of traditional relationship and the emergence of a negative oil relationship for Euro and Swiss.
So based on our estimated post-shale betas, Eurodollar and Swissy exhibited oil betas of approximately 0.05% negative and minus 0.07% per 1% oil move, respectively. Therefore, if crude was to rise by 20% over the following week, our model would imply an expected depreciation of Eurodollar by 1.4% and an expected depreciation of Swissy by negative 1%. These results reflected the post-shale environment in which higher oil prices tend to amplify dollar strength against European currencies, driven by negative terms of trade effects, where oil plays a central role in Europe's industrial cost base and consumption basket.
So Li, Fed rate cut expectations have been scaled over the past week in response to upside inflation risks from higher energy prices. Do you still expect Fed to lower rates this year? Yeah, it's a good question.
Like you say, I think the market has been pushing back expectations for the timing of the next Fed rate cut in response to the energy price shock going on in the Middle East. Obviously from our perspective and the Fed's point of view, obviously they're watching closely to see how long this energy price shock persists. Obviously the bigger the move higher in energy prices and the more persistent higher energy prices are, the more the Fed would be uncomfortable to lower rates further this year.
Having said that though, today we've also just had the release of the latest payrolls data from the US for the month of February. It did show a significant slowdown again in employment growth at the start of this year, reversing all if not more of the gains that we saw in January. So if you take the two months together, which have been very volatile at the start of this year, it does point towards private employment growth of around 20,000 to 30,000 per month on average, which to us historically is still very weak.
I think it does sort of raise questions again about the health of the US labor market. That's something which the Fed will need to watch very closely. If we continue to see such weak employment figures in the coming months, it will put pressure on the Fed to consider lowering rates further.
Like you say, with inflation risks also increasing at the same time, the Fed is being put in a more challenging situation as the threats to their dual mandate are diverging. I think the Fed would tend to have to put more focus on the labor market if that really does continue to deteriorate and to cut rates further, which is still our view. But like you say, the inflation dynamics certainly make it more challenging for the Fed to keep cutting rates in the near term, and that is helping to provide some support for the dollar as well.
But we don't see a similar scenario to back in 2022, obviously on that occasion after the Ukraine conflict started and we saw another big energy price shock during 2022. The Fed was very quick to raise interest rates. Their policy rate started closer to the zero bound, and they raised rates aggressively by over 400 basis points in 2022.
And that was a key reason why the dollar strengthened so sharply by about 20% in 2022. Whereas on this occasion, we would argue that the policy rate is already in kind of mildly restrictive levels and that there isn't the same pressing need for the Fed to consider hiking rates as quickly on this occasion. So thanks for listening to today's podcast and thanks, Abdullah Hood, for joining us as well.
Have a good weekend, everyone. Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe.
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