The dollar's resilience since the war began is not a mystery, but it is being misread. The Dollar Index has appreciated roughly 1.8% this month alone, following a modest 0.65% gain in February after January's 1.35% slide. Against every G10 currency, the greenback has advanced since hostilities commenced. All but the Canadian dollar and sterling have surrendered more than 1.5%. The move looks like strength. It is, in part. But it is also a story about positioning, leverage, and the jump in US rates.
Unpacking Safe Haven
Two channels are driving the dollar's gains. The first is mechanical: short
covering. For months, traders had used the dollar as a funding currency;
borrowing cheap in greenbacks to reach for yield in Latin American bonds, for
example, and other higher-beta assets. When those risk positions went south, and
they invariably do, they were sold, and the funding currency was bought back,
which gives the appearance of safe-haven demand.
Another layer of the same dynamic came from foreign equity investors who had
been financing the US current account deficit, and many of them with dollar
hedges layered on top. As US stocks tumbled, the shares were liquidated and the
short-dollar hedges were lifted, or, for some, the drop in equity values left
them simply over-hedged, and they trimmed accordingly. Either way, the bid for
dollars was structural, not discretionary.
The second channel is more recognizable as genuine safe-haven demand. War
compresses risk appetite, and with the United States now the world's largest
energy producer, some investors judge the American economy as comparatively
insulated from the oil shock radiating out of the Gulf. That is a reasonable,
if incomplete, argument. It is also the kind of narrative that tends to have a
shorter shelf life than the positioning adjustment does.
US Rates more than Differentials in the First Instance
What is less appreciated is how sharply the rates landscape has shifted, and
how that is influencing the dollar in ways that go beyond the usual interest
rate differential logic. Since the war began at the end of last month, the
two-year Treasury yield has risen roughly 53 basis points. The ten-year yield is
up about 45 bp. While theory says interest rate differentials are important, in
the short run the jump in US rates seems to offer a better explanation of the
dollar’s strength. Perhaps when rates spike on supply shocks and inflation
fears rather than growth optimism, it changes the dynamics.
And then there is the Federal Reserve. Before the war, fed funds futures had
fully priced two cuts this year and assigned roughly 40% odds to a third. By
the time, the FOMC met last week, some of that easing had been walked back, but
the market still expected at least one cut. The statement moved the needle
little. It was Chair Powell's framing in the press conference that did the heavy
lifting. He played down the seemingly incongruous projections which showed the
median view having increased the GDP forecast and growth forecasts while
keeping the unemployment rate steady and repeating the one rate this year that
was seen in December 2025.
Powell was also unusually candid about the Fed's limitations. He
acknowledged that missing the inflation target is more the norm than the
exception in recent years and that the war poses genuine challenges for both
mandates simultaneously.
Higher Prices Bite
Meanwhile, at the gas pump, the political economy is shifting in real time.
Retail gasoline prices have risen every single day since the war began —
weekends included — adding roughly a dollar per gallon to bring the national
average close to $4.00. Grocery prices appear to be following. This is the kind
of inflation that is felt viscerally, that does not require an economics degree
to understand, and that generates political pressure with a speed that
quarterly GDP estimate does not.
Against this backdrop, the Fed's framing of the labor market deserves
scrutiny. Powell's characterization of "recent stability" downplayed the
loss of 92,000 jobs in February. He acknowledged, correctly, that the
administration's immigration policies have weighed on labor force growth. That
is the third policy (joining the tariffs and war) that are deterring this Fed
and the next chair from being able to deliver the lower rates that the
president has incessantly and angrily demands.
Powell made it clear that he intends to serve as Chair until his successor
is confirmed by the Senate, which will not go forward until the investigation
is over. He also indicated he would not relinquish his governor seat (term runs
into 2028) while investigation is ongoing in any fashion. This is neither
unprecedented nor common. He sees it as a defense of institutional
independence. Markets should take him at his word.
DXY
Technically, the Dollar Index peaked for the year on March 13 near 100.50.
Since then, it has found support just below 99.00, hovering above the 20-day
moving average which now sits a fraction above that level. The index has spent
little time above 100 since mid-last year, and the daily momentum indicators
are rolling over from overbought territory. That argues for some consolidation.
But speculative positioning, though it has shifted dramatically — net long euro
positions collapsed from around 150,000 contracts to barely 20,000, and the
market has swung to nearly 70,000 contracts net short yen — does not yet look
extreme enough to make a compelling case that the adjustment is finished,
especially with the fear the war escalates wafting in the air.
The war premium in the dollar is real. So is the rate support. But both are
contingent on an escalation path that remains deeply uncertain. The five-day
pause announced this week is being viewed skeptically, and rightly so. There
still seems to be a risk that the war escalates. The US is moving more troops
to the area, and this is spurring speculation that the US could take Kharg
Island, a critical export facility for Iranian oil.
Until there is more clarity, the greenback will retain a bid. When clarity
comes, the unwind could be swift. We have seen a couple of such responses.
Reviewed by Marc Chandler
on
March 25, 2026
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