The Middle East war changes everything. And President Trump's demand for an unconditional surrender makes a near-term off-ramp more difficult to envision. Moreover, the impact ripples through a wide swath the global economy. Food is very oil and gas intensive, taking into account transportation, fertilizer, and pesticides. Worker remittances are important to many developing nations and the GCC (Saudi Arabia, UAE, Qatar, Kuwait, Oman, Bahrain) has a workforce composed of over 70% migrant workers, making it one of the top remitting regions globally, estimated around $135 bln in 2024. The nationals are often from India, Bangladesh, Pakistan, Philippines, Egypt, and Ethiopia
A quick survey of Fed, IMF, NBER, and Brookings finds, as you would imagine, a broad range of estimates of the quantitative impact. A 10% rise in the real price of oil boosts headline inflation by 0.15-0.4 percentage points in the first year. A 2024 paper by the Fed staff was at the lower end of the range. The impact on core prices, in the first year, is seen around 0.06-0.08 percentage points, reflecting the higher cost of production. The estimates for the drag on growth in the first year range from about 0.1 to 0.3 percentage points.
There is a strong regularity in the data that US recessions have nearly always been proceeded by a surge in oil prices. Economists are often careful to note that oil may have been a contributing factor, but not always the primary cause. There seem to be two notable exceptions. The 1960 recession was not preceded by a rise in oil prices. And the oil surge in 2003 did not lead to a recession. And this, coupled with the smaller US interest rate premium, or larger discount, informs our negative dollar view, even if last week did not mark an extreme.
US
Drivers: The Middle East war has spurred strong dollar gains. On one hand, this may be seen as an indication that is safe haven status is intact. Yet, we suspect it is more complicated. The dollar was used as a funding to currency to buy high yielding and more volatile assets. When those assets were sold the funding currency was bought back. Similarly, but slightly different, US equities were bought on a dollar hedged basis, and as US stocks were sold, the short dollar hedge was bought back. At the same time, the inflationary implications have spurred the market to push back the next Fed cut into September from June/July previously. The unexpected weakness in the US February jobs data slowed the dollar's rise, but the data was marred by poor weather, strike activity, and statistical adjustments, like new Census Department population revisions.
Data: Ahead of the FOMC meeting (March 17-18) focus turns to inflation with the February CPI and January PCE deflator. Price pressures remain sticky but there seems to be wide recognition that tariffs have contributed to the slow progress. Headline CPI looks flat at 2.4%, while the core rate may have slipped to 2.4% from 2.5%. The core PCE deflator may have edged up to 3.1% from 3.0%. Yet, with practically no chance of a change of FOMC policy until closer to mid-year at the earliest, the impact, outside of the reaction to the news, will likely have little sustained impact. January trade figures and personal income and consumption are useful inputs into Q1 26 GDP projections. The Atlanta Fed's GDP tracker sees 3% growth while the median forecast in Bloomberg's survey is for 2.3%. Strong Boeing orders probably lifted durable goods orders in January after a 1.4% decline in December. At the end of the week, the US takes another look at Q4 GDP, and the January JOLTS is due, which does not to be the market-mover it previously was. The University of Michigan's preliminary March readings, including inflation expectations, will draw passing attention.
Prices: The speed at which the Dollar Index recovered from the disappointing February jobs data underscore the importance of the war and making important high-frequency data less significant. The Dollar Index made new session highs after the employment data. The timing of its reversal to new session lows seemed to align with President Trump's call for Iran to make an unconditional surrender. Its roughly 1.4% rise last week was the largest weekly gain since the week early last August. Still, the consolidation in recent days looks potentially negative, but last Tuesday's range is key (~98.45-99.70) and a break of it likely will signal the direction.
EMU
Drivers: The combination of higher oil prices and a weaker poses a new inflation threat to the eurozone, if sustained. Another energy shock will also weigh on the industrial sector, which appeared to have found traction in recent months. The war appears to spur a new fissure in the eurozone. Spain and France have objected most strongly, while Germany's Merz has broadly backed the strikes on Iran, especially after Tehran stuck out at numerous countries in the region. The US has threatened a trade embargo against Spain, which it threatened last year, as well, over Madrid's refusal to adhere to the defense spending agreed at NATO. Spain runs a modest trade deficit with the United States.
Data: Industrial output in the eurozone likely began the year with a small gain after falling 1.4% in December. Infrastructure and defense spending is expected to bolster output this year. Eurozone industrial production rose an average of 0.1% a month in 2025 after it fell by an average of 0.1% a month in 2024. There is little of a change in policy at the conclusion of the ECB's March 19 meeting.
Prices: Neither the shift in market expectations toward an ECB rate hike nor the disappointing US jobs data lent the euro support. The three-day low ahead of the weekend was recorded after the jobs report. Although it managed to recover (back to ~$1.1620), it settled last week below the 200-day moving average (~$1.1675) for the first time in nearly a year. A move above last Tuesday's high (~$1.1705) is the key to a near-term recovery. Otherwise, congestion may be the best case. On the downside there may be some support near last November lows (~$1.1470-$1.1500), but the downside risk may extend toward into the $1.1340-60 area.
PRC
Drivers: The yuan's steady appreciation against the dollar stalled at the end of February, and the greenback's broader gains saw it rise to almost CNH6.95 (from ~CNH6.8365 on February 26). China is the largest importer of oil, and the bulk goes through the Strait of Hormuz. Still, reports suggest large public and private inventories have been accumulated. While the war may change the tactics, we suspect the strategic efforts to allow gradual appreciation of the yuan will continue. The rolling 30-daty correlation between changes in the Dollar Index and the dollar against the offshore yuan has risen to about 0.60, the highest this year.
Data: China reports February CPI and PPI to start the new week. Consumer prices are rising slowly, and the core rate is slightly firmer. Producer price deflation persists but appears to be slackening. China may report the politically sensitive trade figures. Although little attention has been paid by the press, Beijing has reduced tariffs on most African countries’ exports to China to zero.
Prices: The Middle East war stalled the offshore yuan's strengthening trend. The offshore yuan fell last week, snapping a four-week advance. It was only the third weekly decline in the past 15 weeks. Still, the dollar has recorded lower highs for the past four sessions but consolidated in the range set Tuesday, March 3 (~CNH6.8750-CNH6.9525). The PBOC says it will promote yuan stability. The dollar's reference rate fell by nearly 0.25% last week. It has not risen since late November, which itself was the first increase since the end of last September.
Japan
Drivers: Although Japan is a large importer of oil, the rolling 30-day correlation of changes in the dollar against the yen and WTI is hardly above zero (0.08). Early last November, the correlation was near -0.60. The correlation has been inverse for the most of the past three months. The correlation between changes in the exchange rate and US two- and 10-year yields remain at the lower end of recent ranges (~0.25-0.30). The rolling 30-day correlation of the changes in the exchange rate and Japan's 10-year yield is around -0.20, while the correlation with Japan's two-year yield is near -0.35, near the most extreme since last October. The rolling 30-day correlation of changes in DXY and the dollar against the yen is a little above 0.75. It has not been above 0.80 since early last October. In the swap market, the odds of a BOJ hike in H1 26 have been scaled back. It was fully discounted as recently as mid-February. Now, pricing suggests around an 85% chance.
Data: Japan's current account typically (19 of past 20 years) deteriorated sequentially in January. Japan's current account surplus is not driven by the trade balance but the return on past investment (interest income, royalties, licensing feeds, profits, etc.). The market may be sensitive to news on tourism, given anecdotal reports of Chinese boycotts. While Japanese labor cash earnings are rising near 2.5% year-over-year, they have not kept pace with inflation (leading to a decline in real wages). Still, with price pressures moderating, there may be some relief here. The last time real wages rose on a year-over-year basis was the 0.3% increase in December 2024.
Prices: The US dollar briefly traded above JPY158 at the end of last week, its best level since the Fed/US Treasury checked rates on January 23. The market does not seem persuaded by Japan's minister of finance threatening to intervene in the foreign exchange market. It is not so much a weak yen story as it is a strong US dollar story. In fact, last week, the yen's little more than 1% loss made it the fourth best performer within the G10 currency complex. The yen appears to have been used a bit as a funding currency to purchase higher yielding instruments and as the instruments were sold, the yen was bought back.
UK
Drivers: Sterling is not particularly sensitive to the changes in the price of Brent oil. The rolling 30-day correlation of changes in sterling's exchange rate and Brent is at the lowest of the year (~0.05). It was near 0.40 at the end of January, which was slightly above last year's high set in May. It was -0.60 last September. The correlation was inverse most of the 2025. The correlation with changes in UK yields (two- and 10-year rates) is inverse. Sterling remains strongly inversely correlated with changes in the Dollar Index0 (~-0.8). It has been more extreme than -0.70 since last August.
Data: In relatively quiet week for UK data, the January monthly GDP is due at the end of the week. The British economy expanded by 0.1% in December and in Q4 as a whole. The economy still looks fragile at the start of the new year, and the swaps market has about an 85% chance of a cut at the March 19 Bank of England meeting. Industrial output fell by 0.9% in December and may have stabilized in January. Construction output fell by 0.3%, while the index of service activity rose by 0.3%.
Prices: Sterling spent the last three sessions in a roughly $1.33-$1.34 range, which was inside last Tuesday's wide range (~$1.3255-$1.3425). After the Canadian dollar, it was the best performing in the G10, losing about 0.85%, and managed to eke out a modest gain ahead of the weekend. Its bounce stalled after new session highs were recorded near $1.3410. A move above $1.3425 is needed suggest a bottom is in place. A week ago, the swaps market was discounting two rate cuts this year fully and now there is a little more than a 55% chance of a single cut.
Canada
Drivers: While the Canadian dollar has performed the best among the G10 currencies since the Middle East war began, we argue it is not due to its ties to oil as much as the US dollar itself. Oil and gas account for 20-25% of Canada's total goods exports and no more than 8% of its GDP. Oil and gas account for 55-57% of Norway's goods exports and 20-25% of its GDP. The Norwegian krone has fallen by almost 1.5% against the US dollar over the past week compared with the Canadian dollar's 0.35% decline. The Canadian dollar often acts as a sort of proxy for the US dollar. In a rising US dollar environment, the Canadian dollar generally outperforms. And the opposite is true in a soft US dollar environment. Recall in Q1 25, when the greenback declined broadly, the Canadian dollar was the only G10 currency not to have gained against it.
Data: The disruption from the US aggravated Canada's merchandise trade deficit last year. It swelled to C$31.3 bln from C$7.2 bln in 2024. Canada reports February employment data at the end of the week. Although overall job growth slowed to 211k in 2025 from 404k in 2024, the striking comparison is Canada created more jobs last year than did the US which is around 13x bigger. US economy added 180k jobs in 2025. Still job growth did not keep up with the participation rate, and the average unemployment rate rose to a little above 6.8% last year from a little below 6.4% in 2024. The swaps market has a modest bias toward another cut later this but at the March 18 central bank meeting, a steady course is the most likely scenario.
Prices: The Canadian dollar was the only G10 currency to rise against the US dollar last week. The Norwegian krone, which as we noted appears more tied to oil than the Canadian dollar fell by about 0.90. The US dollar has pushed above CAD1.37 on an intraday basis around nine times in the past three weeks and failed to settle above it once. A frustrated market took the greenback to its lowest level in nearly since February 12 ahead of the weekend, slightly below CAD1.3565. The next support area is last month's low around CAD1.3500.
Australia
Drivers: The Middle East war has injected some volatility into the Australian dollar, but the central bank remains hawkish. The fall in gold did the Aussie no favor. The rolling 30-day correlation between changes in the Australian dollar and gold is around 0.70, higher than all of last year., though off the peak near 0.80 reached in early February. The correlation with changes in copper is a little below 0.50. Meanwhile, the rolling 30-day correlation of changes in the exchange rate and changes in Australia's two-year yield is slightly inverse for the first time since last November.
Data: In an otherwise, quiet week for high frequency data, Australia's Melbourne Institute's consumer inflation survey will draw attention. It was near a two-and-a-half year high, slightly above 5% in February. Without a significant pullback, which seems unlikely, the central bank's March 17 meeting will likely put the market on notice of the risk of a rate hike at the next meeting, in early May.
Prices: The Australian dollar chopped in last Tuesday's range (~$0.6945-$0.7125) for the past three sessions. The weaker tone saw the five-day moving average fall below the 20-day moving average for the first time since mid-January. A break of Tuesday's low could signal a test on more formidable support near $0.6900. It also marks the about the halfway point of the rally from the year's low set January 5 (~$0.6665). The Aussie has not settled below there since January 23. On the other hand, it tested resistance near $0.7050 ahead of the weekend and above above there and a would lift the technical tone.
Mexico
Drivers: Risk-aversity took a toll on the Mexican peso. The rolling 30-day correlation of changes in the US-MXN exchange rate and the S&P 500 reached nearly -0.65, the most extreme since last November. Many longs appeared to have been forced out on the 4% slump in the peso last week, at the pre-weekend's worst. Still, we expect buyers to re-emerge quickly when there are signs of stability.
Data: Mexican growth looks sufficient keep recession fears in check and allow the central bank time for price pressures to ease. February CPI is likely to see the headline rate edge a little closer to 4%, the upper end of the 2-4 target range. The core rate has been above 4% since last April. January industrial output is due at the end of the week. It rose by 0.2% in December and although vehicle production increased in January, overall industrial production may have struggled.
Prices: The dollar reached MXN17.9175 ahead of the weekend, its highest level since January 13. The dollar stalled as the S&P recovered from its initial steep decline and ahead of the MXN17.9285 area, which is the halfway mark of the greenback's decline from the early November 2025 high (a two-month peak at the time). A move above there would likely signal a test on MXN18.00 and possibly the MXN18.13 area, another technical retracement target. The greenback settled above its upper Bollinger Band for the second consecutive session, ahead of the weekend, and the third time in the past four sessions. Note that last week, Latam currencies accounted for three of the six worst performing emerging market currencies, with the Chilean peso (~-4.3) and Peruvian sol (~-3.6%) joining the Mexican peso (~-3.2%). The Brazilian real fell by about 2.2%, while the Colombian peso slipped by slightly more than 0.6%.
Reviewed by Marc Chandler
on
March 07, 2026
Rating:
