Geopolitics has determined the forex leaders

For the third time in the last three weeks, the US dollar has rebounded from its lowest levels since February, thanks to the latest escalation in the Middle East. US ships prevented an Iranian tanker from passing through the Strait of Hormuz; Tehran attacked them and faced retaliation. Donald Trump dismissed the skirmish as a minor incident, yet it was enough to turn a 6% decline in oil prices into a 7% rise. Brent rose, and with it the dollar.

The DXY is only slightly higher than it was at the start of March, which is unusual as the greenback typically strengthens during periods of geopolitical turmoil. However, this time, the success in March was followed by a rout in April, as investors rushed to capitalise on the end of the conflict.

Moreover, the US currency did not start the conflict in the best of spirits. Uncertainty over White House policy was undermining confidence in the dollar, whilst the Fed was set on cutting rates. Investors believe that once the conflict in the Middle East ends, the old fears will sink the greenback.

The leaders among the G10 currencies during the armed standoff between the US, Israel and Iran are the Australian dollar and the Norwegian krone. These are the currencies of energy-exporting countries, where key interest rates are also rising. The pound is looking strong, as the Bank of England is expected to tighten aggressively amid fears that inflation could return to 5% by the end of the year.

The US dollar is capitalising on its status as a safe-haven asset and on the Fed’s intention to keep rates high amid rising inflation expectations. Such dynamics could become a self-fulfilling prophecy, as domestic demand will rise in anticipation of higher prices, fuelling inflation.

The Fed may tighten monetary policy provided the labour market stabilises. In this regard, US employment figures for April, which are close to forecasts, will lend support to the dollar.