The dollar’s strength since the onset of the war is not surprising, but it is often misunderstood. The Dollar Index has climbed about 1.8% this month, following a smaller 0.65% gain in February after a 1.35% drop in January. Since hostilities began, the dollar has risen against all G10 currencies, with most—except the Canadian dollar and sterling—falling more than 1.5%. While this appears to reflect broad strength, it is equally a function of positioning, leverage, and rising US interest rates.
Reassessing Safe-Haven Flows
Two main forces are behind the dollar’s advance. The first is mechanical: short covering. For months, investors had used the dollar as a funding currency, borrowing cheaply in USD to invest in higher-yielding assets like Latin American bonds. When those risk trades reversed, positions were unwound and dollars were bought back, creating the illusion of safe-haven demand.
A similar process occurred among foreign investors in US equities. Many had hedged their dollar exposure while financing the US current account deficit. As US stocks declined, these investors sold equities and unwound dollar hedges—or found themselves over-hedged and adjusted accordingly. In both cases, the resulting demand for dollars was structural rather than discretionary.
The second driver is more traditional safe-haven demand. War reduces risk appetite, and with the US now a major energy producer, some investors view its economy as relatively shielded from oil shocks. While this argument holds some merit, it is likely to be less durable than the effects of positioning adjustments.
The Role of US Interest Rates
What is less widely recognized is how sharply US interest rates have risen, and how central this has been to the dollar’s strength. Since the war began, the two-year Treasury yield has increased by about 53 basis points, while the ten-year yield is up roughly 45 basis points. Although interest rate differentials typically matter, in the near term, the sheer rise in US rates appears to be a more decisive factor—especially as these increases are driven by inflation fears and supply shocks rather than optimism about growth.
Fed Expectations Shift
Expectations for Federal Reserve policy have also changed. Before the conflict, markets had fully priced in two rate cuts this year, with some probability of a third. Even after some repricing, at least one cut was still anticipated. However, while the Fed’s official statement had limited impact, Chair Powell’s press conference reshaped expectations. He downplayed projections showing stronger growth alongside steady unemployment and reiterated a cautious rate outlook.
Powell also acknowledged the Fed’s constraints, noting that missing inflation targets has become common and that the war complicates both inflation control and employment objectives.
Inflation Pressures Build
Meanwhile, rising fuel prices are shifting the political and economic landscape. Gasoline prices have increased daily since the war began, adding about $1 per gallon and pushing the national average close to $4. Grocery prices are also beginning to rise. This type of inflation is immediately felt by consumers and generates political pressure far more quickly than broader economic indicators.
Powell’s description of labor market “stability” also warrants scrutiny, given the loss of 92,000 jobs in February. He acknowledged that immigration policies are constraining labor force growth—adding to the effects of tariffs and war in limiting the Fed’s ability to cut rates as aggressively as desired.
Powell further emphasized his intention to remain Fed Chair until a successor is confirmed and indicated he would not step down from his governor role during any ongoing investigation, framing this as a defense of institutional independence.
Technical Outlook
From a technical perspective, the Dollar Index peaked near 100.50 on March 13 and has since found support just below 99.00, trading around its 20-day moving average. Momentum indicators suggest some consolidation may be ahead. However, positioning is not yet extreme—euro longs have dropped sharply, and yen shorts have increased—indicating the adjustment process may not be complete, especially amid lingering geopolitical uncertainty.
Outlook
The dollar is supported by both war-related demand and higher interest rates, but both factors depend on how the conflict evolves. The recently announced five-day pause is being met with skepticism, and risks of escalation remain, particularly with increased US military presence and speculation around strategic targets like Iran’s Kharg Island.
Until there is greater clarity, the dollar is likely to remain supported. However, once uncertainty fades, any reversal could unfold quickly—as has been seen in similar episodes before.
Sources: Marc Chandler
THE ETERNAL SOVEREIGN 
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