The FX market seems to have lost interest in the Middle East conflict. Perhaps it never had much interest in the first place. After all, the DXY measure of the US dollar against other G10 currencies only rose by less than 3% in the weeks after the Middle East conflict started, and it has now given back just about all of these gains.

Of course, the US dollar does still rise and fall depending on the latest headline from Iran or from the White House, but the movements are tiny. The euro/dollar can’t get out of a very small 1.14-1.20 range, while the US dollar/yen has become stuck like glue to 160, a level that the market rightly or wrongly sees as a line in the sand for the Bank of Japan.

With all this in mind, we have to wonder whether geopolitical conflict-related uncertainty is actually preventing the US dollar from moving and that, once the conflict is over, the US dollar can revert to a more ‘natural’ path. “Our sense is that this more natural path is one of weakening. One reason for this is that we would ordinarily expect the US dollar to rise materially and retain gains on the outbreak of a conflict that both lifts energy prices substantially and creates extreme risk aversion," said Steven Barrow, Head Strategist of the Standard Bank.

However, the US dollar’s petro status and its safe-asset status do not seem to be what they once were. This may be because the markets' natural desire is to shed US dollars such that bouts of strength caused by disturbances such as the conflict merely serve to generate better levels to short the US dollar for most investors.

In addition, the conflict itself could be generating reason to sell the US dollar should investors feel that the US has seen its status as a military power undermined by the fact that it has not been able to achieve its objectives, at least so far. So, once the conflict ends, Steven Barrow would expect the US dollar to break above the top of the 1.14-1.20 range against the euro and to peel back from the 160 level against the yen.

As well as a weaker longer-run trend against the euro and yen, Steven Barrow expects the US dollar to cede ground to the pound. However, a key point here is that US dollar weakness is likely to be the catalyst for sterling to push on to over 1.40 rather than sterling strength.

In fact, in the short-term at least, the pound appears vulnerable across other G10 currencies for two reasons. The first, as highlighted by the IMF last week, is that the UK economy is more vulnerable than most to the surge in energy prices resulting from the war in Iran. Steven Barrow too thinks this is the case. The UK is at least likely to flirt with recession this year, if not experience a technical two-quarter recession around the middle of the year.

The second issue is politics. Once again Prime Minister Starmer finds himself under substantial pressure as a result of his decision to appoint discredited former Labour minister Peter Mandelson as ambassador to the US in 2025. He has since been sacked, but the legacy of his appointment could be Starmer’s ousting as PM.

While many people do not think that this scandal, per se, will cause Starmer’s demise, even though things will be very tricky this week as he accounts for his actions to parliament, the May 7th local elections could provoke a revolt from within the Labour Party if the results are even worse than the dire outcome predicted. The prediction markets had put a high probability of an ouster for Starmer when the Mandelson furor started earlier in the year. The conflict in Iran allowed the PM to claw back some support, but that’s evaporating again even if the market-implied odds of his departure by the end of June are only just over one-in-three.

Sometimes, the prospect of a change in political leadership can boost a currency, but not in this case. This is because most challengers to Starmer are likely to come from the left wing of the Party and the fear will be that the tough fiscal line taken by Chancellor Reeves, and supported by Starmer will give way to fiscal largesse as Reeves would likely be replaced by a Chancellor that’s more amenable to a looser interpretation of fiscal rules. In short, the odds of Starmer being replaced might be still quite low, but the consequences of an ousting could be considerable when it comes to the pound.