Currency markets were subdued as investors moved to the sidelines, waiting for clearer signals about the trajectory of the U.S.-Israeli military campaign against Iran. The dollar held its ground on the cautious tone, after earlier gains that accompanied a spike in oil prices when hostilities began.
Financial markets have been pricing in the possibility that U.S. President Donald Trump may pursue a path that would conclude the conflict quickly. At the same time, statements from the president have included repeated threats to strike Iran hard to prevent disruptions to energy flows through the Strait of Hormuz. Those mixed messages have kept market sentiment fragile and left traders hesitant to take decisive positions.
Earlier in the conflict, the dollar strengthened as crude prices surged, but it has since surrendered some of those moves on hopes for a swift resolution. Still, analysts said they see little evidence that the fighting will wrap up imminently. "We expect the war to run for months, not weeks, while acknowledging the high level of uncertainty," said Kristina Clifton, senior currency strategist at Commonwealth Bank of Australia.
On the ground and in the skies, the conflict escalated with U.S. and Israeli strikes that the Pentagon and Iranian forces described as the most intense air attacks of the war to date. In retaliation, Iran’s Islamic Revolutionary Guard Corps said it would block oil shipments from the Gulf unless the U.S. and Israel halted their attacks, raising the economic stakes for global energy markets.
With developments changing rapidly, traders have struggled to price the evolving risks. For now, market participants appear to be waiting for greater clarity before committing capital. "Traders are largely sitting on their hands and waiting for further news and greater clarity so that risk can be priced more efficiently," said Chris Weston, head of research at Pepperstone.
Currency specifics in early Asian trade reflected that caution. The euro was trading at $1.16205, slightly firmer than the three-month low it hit on Monday. Sterling was modestly higher, up 0.12% at $1.34305. The dollar index, which tracks the U.S. currency versus six peers, stood at 98.876, easing away from the three-month top recorded on Monday.
The Australian dollar, a currency sensitive to global risk appetite, hovered near the nearly four-year high it reached on Tuesday and last traded at $0.713. Much of Australia’s currency strength followed comments from Reserve Bank of Australia Deputy Governor Andrew Hauser, who warned that the jump in oil prices would push inflation higher and increase pressure for a rate rise at the bank’s policy meeting next week.
Central bank expectations have shifted since the conflict began at the end of February, with many markets moving away from pricing in cuts and toward pricing hikes, or at least smaller reductions than previously expected. "The war in the Middle East has had some large impacts on expectations for central bank interest rates," Clifton said.
At the same time, futures tied to the federal funds rate now imply 39.7 basis points of cuts by year-end, signaling growing doubts that the U.S. central bank will implement a second 25-basis-point cut this year.
Investors are also focused on incoming U.S. inflation data for February, due later in the day. Economists polled expect core consumer prices to have risen by 0.2% in the month, with headline inflation up 0.3%.
Adding to efforts to blunt the rise in crude, the International Energy Agency has proposed what was described as the largest release of oil reserves in its history to help bring down the sharp increases in oil prices caused by the conflict.
Summary
Markets have become cautious as the U.S.-Israeli campaign against Iran intensifies and Iran threatens to block Gulf oil shipments. The dollar steadied after earlier gains, while traders await U.S. inflation data and further clarity on the conflict. Central bank rate expectations have shifted amid the oil shock, and the IEA has reportedly proposed an unprecedented release of oil reserves.
Key points
- Geopolitical tensions - The U.S.-Israeli strikes on Iran and Iran’s threat to block Gulf oil shipments have kept markets wary; this affects energy and commodity-linked sectors most directly.
- FX market reaction - The dollar strengthened early in the war then gave back some gains as hopes for a quick resolution emerged; major currencies showed modest moves versus the dollar.
- Monetary policy implications - Rising oil prices have shifted expectations for central bank actions, influencing rate-sensitive sectors like financials and housing.
Risks and uncertainties
- Conflict duration - Analysts warn the war could last months rather than weeks, creating prolonged volatility for oil markets and currencies.
- Oil supply disruption - Iran’s stated willingness to block Gulf shipments unless attacks stop raises the risk of sustained crude price shocks, impacting inflation and energy-intensive industries.
- Monetary policy uncertainty - Changes in inflation driven by higher oil prices complicate central bank decisions, with implications for bond markets and interest-rate-sensitive sectors.