Dollar strength returns as oil shock spreads

The US dollar is regaining strength as an oil shock spreads through global markets. Rising tensions near the Strait of Hormuz have pushed crude prices sharply higher, reviving inflation concerns and unsettling risk assets. As energy prices climb, investors are increasingly turning to the liquidity of the US currency, lifting the US Dollar Index against many major and emerging-market currencies.

Reports from major news outlets indicate that crude has climbed above the 100 USD level amid tanker incidents and fears of supply disruption. As volatility rises, markets appear to be rebuilding the dollar’s traditional safe-haven role during periods of global stress.

The dollar rebuilds its safe-haven premium

In the early phase of the conflict, markets moved unevenly as traders weighed the possibility of a quick de-escalation against the risk of a broader regional crisis. Over the past two weeks, however, the narrative has shifted toward the potential for a more persistent macro shock.

News reports that the dollar has strengthened against a wide range of currencies as investors unwind carry trades and increase allocations to US money-market funds and short-dated Treasuries.

Strategists at several global banks say two structural factors are supporting the currency.

First, the United States is now a net energy exporter. A sustained oil rally therefore tends to hurt the US economy less than major importers such as Europe or Japan.

Second, higher energy prices risk keeping global inflation elevated. If inflation proves persistent, central banks may delay interest-rate cuts. That outlook could keep US yields higher relative to other advanced economies and reinforce dollar demand.

USD/JPY approaches intervention territory

Few currency pairs reflect these forces as clearly as USD/JPY.

The yen has weakened as oil prices rise and US yields climb, pushing the pair back into the high-150s. That leaves the exchange rate approaching the 160 level that previously triggered large-scale intervention from Japanese authorities in 2024.

Analysts report that officials in Tokyo have intensified warnings about excessive currency moves while stopping short of signalling immediate action.

Japan’s vulnerability stems partly from its energy dependence. The country imports most of its fuel, much of it through Gulf shipping routes. Rising oil prices increase the cost of imports and boost demand for dollars to pay for energy supplies.

Several analysts describe this as a negative terms-of-trade shock for Japan. At the same time, interest-rate differentials remain wide. The Bank of Japan has only gradually begun normalising policy, while US rates remain comparatively high.

That gap continues to support carry trades in which investors borrow in yen and invest in higher-yielding dollar assets.

Intervention risk adds volatility

Despite the macro forces supporting USD/JPY, the threat of intervention remains a key risk.

If the exchange rate approaches or moves through previous intervention levels too quickly, Japan’s Ministry of Finance could step into the market. Past interventions have triggered sharp reversals in the pair even when broader economic conditions still favoured a stronger dollar.

Options market data cited by market commentators suggest traders are increasingly hedging against that possibility. Demand for protection against sudden yen strength has risen, reflecting the risk of abrupt moves if authorities act.

Pressure spreads across global markets

The stronger dollar is also influencing other parts of the financial system.

Risk-sensitive currencies such as the Australian dollar and several emerging-market currencies have weakened as investors reduce exposure to growth-linked assets. The euro has also struggled to hold gains amid concerns that the eurozone remains highly exposed to rising energy costs.

Gold initially rallied when tensions escalated, reflecting demand for traditional safe-haven assets. More recently, however, the metal has struggled to extend those gains.

Experts note that higher real yields and a stronger dollar have capped bullion’s upside as investors rotate into cash and short-dated Treasuries offering competitive yields.

Equity markets have also reacted cautiously. Global indices have given back part of their earlier gains as investors reassess the outlook for growth, inflation, and interest-rate policy.

What markets are watching next

Positioning data suggests investors have quickly rebuilt long-dollar exposure. Flows into money-market funds and Treasury securities have increased as traders prioritise liquidity.

Market participants are now focused on three developments: the trajectory of the Iran conflict, the impact of higher energy prices on inflation data, and the response from Japanese authorities if USD/JPY approaches earlier intervention levels.

For now, elevated oil prices, persistent inflation risks, and wide rate differentials continue to support the dollar. But with geopolitical tensions high and intervention risk rising, currency markets may remain volatile in the weeks ahead.

‍