MUFG’s Derek Halpenny and Abdul-Ahad Lockhart highlight that renewed Middle East conflict risks and rising Oil prices are reinforcing upside risks for the Dollar. They note that higher energy costs are fuelling inflation concerns at the Federal Reserve, with officials turning more hawkish. MUFG argues that if peace prospects do not improve, higher US yields and stronger rate–FX correlations should support further Dollar strength.

Higher yields and conflict risk support Dollar

"The growing confidence amongst investors that a peace deal would soon be reached has taken a hit but the reversal in the financial markets has been very limited so far."

"But the consequence of re-escalation into conflict would be severe. And the inflation risks are building which will likely result in a greater number of FOMC officials expressing concerns over inflation rather than growth. The surge in equities, the AI-driven optimism and the relative stability in the labour market leaves inflation risks front and focus."

"Minneapolis Fed President Kashkari warned earlier that inflation was “much too high” and that the longer inflation stays high the more the Fed may have to respond. Chicago Fed President Goolsbee has just stated that inflation has been above target for years and now heading in the wrong direction."

"Of course, it is difficult to predict short-term developments in the Middle East and we could suddenly see prospects of a peace deal revived but if that doesn’t happen then US yields will see a renewed move higher and with yield spreads and FX correlations strengthening once again, the FX response will be further dollar strength."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)