• The US dollar is on track for its strongest two-day rally in nearly a year, driven by escalating US-Iran tensions that have spiked oil prices and heightened inflation fears.
  • Treasury yields hit three-week highs, G10 currencies fell over 1%, and options markets turned strongly bullish on the dollar as investors unwind euro and pound positions.
  • Fed rate cut expectations have dropped sharply to 37 basis points for 2026 from 60 last Friday, amid hawkish signals from recent minutes and robust labor data.

A Hawkish Shift Amid Geopolitical Tensions

The dollar's surge, with the Bloomberg Dollar Spot Index jumping 0.8% Tuesday, comes as Brent crude oil prices rose 4% to around $70, after earlier surges to $85 a barrel—the highest since July 2024. European gas prices soared over 40% to their highest since 2023, stoking global inflation concerns. According to people familiar with the matter, real-money investors have been dumping euro and pound longs, flipping options and risk-reversal signals sharply bullish on the greenback, the most since June.

Efforts to curb inflation have hit a snag as the widening Iran conflict risks disrupting energy supplies, pushing the Federal Reserve into a more cautious stance. Fed minutes from January showed some officials eyeing rate hikes if pressures persist, surprising markets with their hawkish tone. "The market is repricing Fed expectations rapidly," said one trader, who declined to be named due to company policy. "With oil volatility persisting, the dollar could grind higher, especially if strikes continue."

Political and Market Implications

White House warnings to Iran to negotiate, coupled with President Trump hinting at military action, have raised the risk of US-Iran conflict. Reports suggest the US is considering strikes on Iran in the coming weeks or by June 2026, with Pentagon involvement noted amid a third day of Iran strikes. This geopolitical uncertainty complicates the Fed's path, as persistent inflation from energy shocks could lock it into a higher-for-longer stance, bolstering the dollar further.

In parallel, robust US labor data has added to the dollar bid, while emerging markets and equities face pressure. Gold's rebound has lifted South Africa equities, and Dubai stocks are at a 12-year best start, with African nations issuing dollar bonds signaling sustained demand. BNP Paribas strategists see this dollar strength as likely to persist, with markets pricing higher US-Iran strike odds by mid-2026. Without a de-escalation, the global economy could see broader disruptions to trade and heightened volatility for retail investors.

Correction: An earlier version of this article misstated the timeline for Fed rate cuts; it has been updated to reflect the current expectations of 37 basis points for 2026.