Good morning. Financial markets are rallying on hopes for a renewal of diplomatic engagement in the Middle East, with some media outlets reporting that US and Iranian negotiating teams could return to Islamabad for talks later this week. Oil prices are retreating, Treasury yields are coming under renewed pressure, equity markets are setting up for a positive open, and most major foreign exchange pairs are trading at or above key technical levels against the dollar. The euro is flirting with 1.18, the pound is holding above 1.35, the Canadian dollar is back in the 1.37s, and even the yen is stubbornly refusing to break below the 160 threshold.
US wholesale prices climbed by less than anticipated last month, affording fixed-income markets a degree of respite ahead of an expected jump in energy costs ahead. The producer price index for final demand—which measures changes in the prices of goods and services produced in the US—climbed 0.5 percent in March after a similar rise in the prior month, the Bureau of Labor Statistics said this morning, undershooting the 1.1 percent expected by economists as oil and gas inputs remained relatively tame. In the 12 months through March, the index advanced 4 percent after rising 3.4 percent in February—a print well below the 4.7 percent consensus forecast, and one consistent with a slightly softer greenback.
On a trade-weighted basis, the dollar’s wartime rally has now been fully unwound, leaving the currency a touch weaker than it stood on February 28th, the eve of the American-Israeli assault on Iran. In past geopolitical convulsions—the Gulf wars, the September 11th attacks, the early months of Russia’s invasion of Ukraine—the greenback surged as global capital sought the safety of American assets. This time it barely budged. Even as oil prices leapt by roughly 60% and risk premia spiked, the dollar managed a gain of just 2.6%—far less than a disruption of this magnitude would ordinarily produce.
Talk of the dollar losing its dominance should be treated with scepticism. Erratic American policymaking, persistent questions about Federal Reserve independence, and mounting concern over the country’s fiscal trajectory have all corroded the currency’s standing as the world’s unimpeachable safe haven. Yet the alternatives remain feeble. The renminbi is tightly controlled, internationally illiquid, and vulnerable to political interference; the euro is hobbled by dysfunction in Brussels and moribund growth; and markets elsewhere are far too shallow to intermediate global capital flows. The network effects that underpin the dollar’s share of foreign-exchange reserves*, cross-border debt issuance, and trade invoicing are not about to dissipate.
Still, there have been subtle changes in the plumbing of global finance. During last year’s “Liberation Day” tariff fiasco, foreign holders of American assets—chiefly Asian life insurers and European pension funds—raised their currency-hedge ratios and shifted long-term allocations, meaning that marginal flows into the dollar may now be structurally less responsive than they were even eighteen months ago. Post-pandemic rate rises have shrunk dollar-funded carry trades and tilted what remains toward commodity currencies, limiting the scramble to unwind when trouble hits. The basis trade cuts the other way, too: spikes in volatility force leveraged funds to dump Treasuries and buy back futures, offsetting the traditional flight to safety. Meanwhile, a proliferation of bilateral swap agreements gives countries facing a liquidity squeeze more options beyond the Fed than they had in 2008 or 2020. Further, the limited capacity of most non-sanctioned oil exporters to capitalise on higher prices—unique to this particular crisis—has likely dulled appetite for front-running petrodollar recycling flows.
Taken in sum, the “dollar smile” is looking less pronounced. The tendency for the greenback to strengthen both when the American economy is sharply outperforming and when global conditions turn dire, yet weaken when growth is moderate and unremarkable, may be weaker than decades of precedent would suggest.
*Note that widely-reported shifts in the dollar’s share of global foreign exchange reserves in recent years largely reflect exchange rate movements, not a strategic pivot among central banks. A similar dynamic applies to overall reserves, where soaring gold valuations have obscured nearly-imperceptible changes in underlying trends.