HSBC argues that recent Middle East tensions and “safe haven” demand have lifted the Dollar, helped by short USD covering and tighter US financial conditions. However, the bank notes that 2022-style drivers such as a clearly hawkish Federal Reserve and weak global growth are absent, and expects a de-escalation in geopolitical tensions to see the USD resume softening, barring a hawkish repricing of Fed expectations.

Safe haven gains but softening bias

"At the onset of the latest Middle East conflict, the USD was poised to rise, consistent with a renewed “safe haven” demand and the potential for de-risking – particularly given the build-up of sizeable, short USD positioning since January."

"USD strength has also been accompanied by tighter US financial conditions, which is typically a headwind for other currencies. However, the tightening has been modest relative to previous stress episodes, suggesting that there may be limits to sustained USD outperformance if cross-asset volatility remains contained."

"Unlike 2022, the key pillars that previously underpinned a structurally stronger USD — namely a clearly hawkish Federal Reserve (Fed) and weakening global growth — are not evident. Markets continue to price a bias towards gradual Fed easing this year, and leading indicators point to firmer global growth."

"Together, these factors can support more cyclical currencies and temper broad-based USD strength, reinforcing our central view that a de-escalation in tensions would allow the USD to resume softening. That said, risks remain skewed to the upside for the USD, if the conflict drives a sharp repricing of the Fed path into hiking territory."

"A further downside scenario would be a prolonged conflict that sustains energy and supply-side pressures and revives stagflationary concerns. In such an environment, the USD will likely be stronger than in our base case, supported by the US being less exposed as a net energy importer and by growth cushioning from the One Big Beautiful Bill."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)