Global currencies swung widely on Tuesday as foreign exchange traders priced in the effects of an increasingly broad supply-side inflationary shock resulting from the Iran war.
The US dollar index (DX-Y.NYB) jumped more than 1% in early trading, while the euro fell nearly 1% against the greenback and sterling slid about 0.8%. The dollar also gained roughly 0.8% versus the Swiss franc and strengthened more modestly against the Japanese yen and Chinese yuan.
The dollar is gaining not only on an index basis but against a basket of other currencies as the market assesses that the United States is less exposed to direct physical supply disruption, though not immune.
The moves suggest markets are shifting away from a traditional risk-off regime — where bonds, safe-haven currencies, and gold would all be expected to rally — and toward assets that perform in a high-interest-rate environment.
“Negative supply shock and risks to growth” should dominate global income reallocation driven by the war, and therefore how currencies perform, economists at Goldman Sachs said in a recent client note.
For currency markets, the surge in energy costs represents a potential terms-of-trade shock, or a sudden change in the price of exports versus imports. This could result in rising import bills, widening trade deficits, and eroding real incomes. The dynamic can pressure a currency even when domestic bond yields are rising.
In prolonged supply shocks, oil-importing economies such as Europe and Japan tend to see currency weakness, while energy exporters like Canada, Brazil, and Norway may experience relative FX outperformance, Macquarie FX and rates strategist Thierry Wizman wrote in a recent client note.
“The likely ‘losers’ in a long War will be the oil importers,” while “the currency and growth out-performers will be countries with large oil reserves and the capacity,” Wizman wrote.
Indeed, the euro declined despite a sharp move higher in European yields, with UK, French, and Italian benchmark rates up more than 10 basis points through the session. Traders have sharply reduced bets on near-term rate cuts from the Bank of England, while expectations for European Central Bank easing have also been pared back.
But higher yields have not provided support to the euro or sterling, underscoring investor concern that sustained energy disruption would damage growth prospects more than it would strengthen monetary policy credibility.
Emerging market currencies tied to energy imports are also under strain, as their central banks have less flexibility to “look through” energy-driven inflation given higher fuel weights in the Consumer Price Index and weaker anchoring of expectations, potentially limiting rate cuts in oil-importing economies, according to economists at Goldman Sachs.
