Rising oil prices linked to the Middle East conflict have supported the US dollar, with the dollar index moving towards the top of the 96.000–100.00 range that has been in place since Q2 last year. The move has been stronger against high-yielding emerging market currencies, including the South African rand and Hungarian forint. Softer US non-farm payrolls data would usually add to expectations for Federal Reserve rate cuts and weaken the dollar, in the absence of the conflict. Instead, the US rates market has repriced, pushing back the timing and reducing the expected scale of further Fed rate cuts, which has lifted US yields and the dollar.

Carry Trade Conditions Deteriorate

Market conditions have become less favourable for carry trades, leading to an unwinding of widely held positions. Currency market volatility is expected to rise if the conflict continues. Last year, we saw how the Middle East conflict created an oil shock that strengthened the U.S. dollar, pushing the DXY index towards the 100.00 mark. This geopolitical risk was so significant that it overshadowed even weak U.S. labor reports, which would normally weaken the dollar. The market priced out Federal Reserve rate cuts, which further supported the greenback against most currencies. The situation has shifted considerably as of March 2026. With diplomatic efforts easing tensions, WTI crude oil prices have fallen from their 2025 highs of over $110 and are now stabilizing around $82 a barrel. This has removed the primary driver of last year’s risk-off sentiment and dollar strength. This easing of energy-led inflation has allowed the Federal Reserve to alter its course. With the latest U.S. CPI data for February 2026 coming in at a manageable 2.5% year-over-year, the Fed initiated its first-rate cut of the cycle last month. This policy pivot is a stark contrast to the hawkish repricing we witnessed during the conflict last year.

Dollar Index Breaks Lower

As a result, the dollar index has weakened, breaking below the 96.000 to 100.00 range that held for much of 2025 and is currently trading near 95.50. We are seeing a reversal of the dynamics from last year, where dollar weakness is now the prevailing theme. This environment suggests traders should position for further, but measured, dollar downside. The unwind of carry trades we saw in 2025 has completely reversed course. Market volatility has subsided, with the VIX index dropping to a calm reading of 14, making it attractive to fund positions with the lower-yielding dollar. Traders should consider using dollar-funded carry trades to buy high-yielding currencies like the Mexican Peso, which still offers an attractive interest rate differential. In the options market, lower implied volatility makes buying options strategies more affordable than they were during the peak conflict last year. Traders could look at buying put options on the U.S. dollar index (DXY) to speculate on a continued downtrend. Alternatively, buying call options on emerging market currencies that benefit from lower oil prices and a weaker dollar presents a clear opportunity. Create your live VT Markets account and start trading now.

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