The US Dollar Will Benefit from a Longer Disruption in Energy Markets

The US dollar is not where the standard playbook says it should be. US data have been beating expectations, while data elsewhere have fallen short (graph 1). US equities have outperformed global benchmarks in recent weeks, which typically signals a net inflow of capital. Yield differentials have stabilized, with markets now pricing the next Fed move as a hike. Most countries that import oil and gas are drawing down inventories or paying up in spot markets. As those buffers erode, the US should remain better supplied, particularly relative to Europe and Asia. In fact, US-based producers have already become the swing supplier for critical jet fuel and LNG.

Zooming in on short-term correlations, the US dollar is trading like a risk-off hedge. Its relationship with yields and rate differentials has weakened in recent weeks, while correlations with equities and oil have strengthened. As graph 2 shows, the DXY Index’s negative correlation with the S&P 500 (lower stocks = higher USD) and its positive correlation with oil (higher oil = higher USD) have both moved to multi-year highs since the war on Iran began.

Zooming out, the price charts tell a different story (graph 3). The widely followed DXY Index is sitting in the middle of its 12‑month range between 96 and 101, while USDCAD has traded in a narrow 1.35–1.41 band. These ranges point to a balanced tug of war between bulls and bears. On one side, state-driven sales of US assets and higher FX hedge ratios by foreign real money have been a drag. On the other, safe-haven demand for the greenback and continued private sector inflows into US assets are providing support. But ranges are made to be broken. Eventually, something will tip the scale.

The Strait of Hormuz remains central to the story. The prevailing view is that oil prices have already peaked, flows through the Strait will resume in the third quarter, Fed cuts will come back into view and the dollar will resume its gradual decline. This is a reasonable base case, but with each day the Strait remains closed, risks are shifting to the other side. The IEA’s latest monthly report External link. notes that global oil inventories are falling at a record pace.

Deeper demand destruction would lift the US dollar. Some oil-importing emerging market economies like India, Indonesia and the Philippines have already seen their currencies plunge due to balance of payment strains. If industrialized economies are forced to drastically cut back industrial use, we expect their currencies would come under pressure too. In that environment, the dollar’s safe-haven status and the US’s relative energy abundance could be the catalysts that break the dollar range to the upside.