The U.S. dollar has given back most of the gains sparked by the Iran war, as a tentative ceasefire revived appetite for riskier currencies, but investors said robust demand for U.S. assets and waning prospects for U.S. interest-rate cuts should buttress it against sharper declines.
The dollar index, which measures the currency’s strength against six major peers, rose more than 3% to a 10-month high of 100.64 after the U.S.-Iran conflict ignited a rush for safe havens. It has since given back most of those gains to trade at 98.07, about 0.5% above where it was before the fighting began.
The dollar skidded 11% in the first half of 2025 following President Donald Trump’s offensive on tariffs and attacks on the U.S. Federal Reserve, as those moves raised investor concerns about the U.S.’s status as a global safe-haven. The flight to the greenback following the outset of the Iran war made it clear investors still see U.S. markets as a sanctuary.
As a result, while the dollar could extend its retreat, investors are skeptical it will break through this year’s low of 95.55. While rising volatility drove U.S. equity fund outflows in early March, investors have returned to stocks as risk sentiment has improved.
“For the dollar to keep breaking down, you basically need capital outflows from the U.S. or at least a reduction in the inflow of capital going into the U.S.,” said Joaquín Kritz Lara, chief economist and strategist at Numera Analytics, a global macroeconomic research firm. “We just don’t see that happening.”
The S&P 500 is on the verge of surpassing its January record high and investors are optimistic that corporate earnings will cushion any repercussions from the Middle East conflict.
INTEREST RATE DIFFERENTIALS
Foreign holdings of U.S. Treasuries rose to $9.305 trillion in January from $9.271 trillion in December, according to federal data, due to elevated yields and expectations shifting away from Federal Reserve rate cuts. Foreign holdings are up 8% year-over-year, reflecting sustained overseas demand even as Treasury issuance has grown to fund rising U.S. deficits.
Markets were pricing in two Fed reductions in 2026, but now see one at most, as surging oil prices from the war added a fresh inflation headache for policymakers already in wait-and-see mode.
The European Central Bank is expected to turn more hawkish as it grapples with the energy shock stemming from the war.
“You would think that that would be bad for the dollar and I think, tactically it probably could be,” Numera’s Lara said. “But in the medium-term you care about the level of interest-rate differentials, and the level of interest-rate differentials are still very much in favor of the U.S. relative to Europe.”
The 2-year German-U.S. bond spread sits at 1.135 percentage points – well below its 2018 peak of around 3.57 percentage points, but still above its 20-year median of 0.93 percentage points. That gap means U.S. assets retain a yield advantage over their European equivalents, acting as a cushion for the dollar.
RANGE-BOUND FOR NOW
For the moment, the U.S.-Iran war is at an uneasy détente, though the twin shipping blockades out of the crucial Strait of Hormuz by both nations have the potential to reignite the conflict.
“Is there any reason for the dollar to be pricing in a zero geopolitical risk premium? I would argue not,” said Paresh Upadhyaya, director of market strategy at Pioneer Investments, referring to the dollar giving back its war-spurred gains. Safe-haven demand could resume if negotiations between the countries fail, he said.
Even dollar bears see little chance of the currency breaking meaningfully below its recent lows anytime soon.
Elias Haddad, global head of markets strategy in the forex team at Brown Brothers Harriman, says the dollar is still weighed down by eroding U.S. fiscal credibility, a persistent current account deficit, and concerns about the politicization of the Federal Reserve that undermines confidence.
But in the interim, the countervailing factors mean the dollar is unlikely to stray far from its current level.
“Over the next six to nine months, the cyclical backdrop for the dollar is neutral,” Haddad said.
(Reporting by Saqib Iqbal Ahmed)
