MUFG’s Lee Hardman says the US dollar rose after an energy price shock linked to the Middle East conflict, but that rise has eased in recent weeks. He links this to expectations that the conflict may end soon and that the Strait of Hormuz could re-open quickly.
He also points to a higher US policy risk premium being priced in, driven by fresh uncertainty tied to the conflict, though it is hard to measure. In addition, short-term yield spreads have moved sharply against the US dollar over the past month.
Fed Outlook And Market Positioning
Fed officials have indicated interest rates may stay on hold for now. Markets remain undecided on whether the next move will be a cut or a hike.
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The US dollar’s rally, which started with the energy shock, appears to be running out of steam. We’ve seen the Dollar Index (DXY) pull back from its late 2025 highs near 108 to trade around 104.50 as of early April 2026. This suggests the initial fear-driven buying has peaked for now.
A key driver is that short-term yield spreads are moving against the dollar. For instance, the US 2-year yield advantage over German bunds has tightened by 30 basis points since February 2026, its lowest level this year. This erosion reduces the incentive for holding dollar-denominated assets over others.
Volatility Breakout Strategies
The market is coiled with indecision over the Federal Reserve’s next move. CME FedWatch data shows an almost even split between a hike or a cut by September, which has pushed implied volatility on major currency pairs to three-month highs. This points to an opportunity to trade the expectation of a large price swing, regardless of direction.
Given this uncertainty, we should consider strategies that benefit from a breakout in volatility. A long straddle in USD/JPY, for example, could be effective in profiting from a significant move once the Fed signals its true intentions. We remember a similar pattern last year in 2025 when the dollar weakened as initial geopolitical fears eased, only to reverse later.
