We still feel that the US dollar is stuck. The euro/dollar remains confined to a really small range between 1.14 and 1.20, while the dollar/yen is stuck like glue to levels just below 160. Until we see some movement here, we are likely to see G10 FX volatility continue to fall.

In the near-term, the most likely source of a recovery in volatility would seem to lie in an ending of the conflict in Iran and a return to more normal oil supplies and prices. But even here, we wonder whether such developments will bring wholesale changes in the FX market. For one thing, we have to remember that the US dollar was very stable before the conflict started in late February.

For after the tariff tantrum this time last year sparked a huge slump in the dollar, the second half of last year and early this year had seen the US dollar settle down again with no clear directional trend against other major G10 currencies. This may hint that there’s no ‘natural’ bias in the market to buy or sell the US dollar that has been stymied by the uncertainty of war.

A second factor is that, while an end to the war might be expected to weaken the US dollar as safe-asset demand for the currency unwinds, the truth is that there had not been much safe-asset demand in the first place. Indeed, all supposed safe-asset currencies—and gold—have not rallied through this crisis.

A third factor is that those countries exposed the most to the vagaries of global oil supply, like Europe and Japan, will still face a lingering economic hit from the war even once the conflict ends.

In contrast, the US not only has a more secure energy supply, but it also has the momentum of AI-related investment, something that may make itself clear once again this week as a number of the so-called Mag 7 tech companies in the US release their results.

In short, the Middle East conflict is likely to have given the US a growth advantage and possibly an inflation advantage as well, and that could bolster the dollar once the war is over even if the market's first reaction to the ending of the conflict is to sell the dollar. Of course, countries or regions facing higher inflation as a result of the war could lift policy rates. Might that aid their currencies, especially if the Federal Reserve refuses to hike and perhaps cuts as the market suspects?

Steven Barrow, Head Strategist of the Standard Bank is not so sure that future rate hikes from the likes of the BoJ, ECB, BoE and more will give their currencies a lift. For a start, the hikes will be a response to inflation risks created by an adverse supply shock (higher energy prices) not a positive demand shock, and that makes a difference to how currencies respond, as rate hikes born of supply shocks are rarely supportive for the currency. So, here too we see little reason to be down on the US dollar for the moment.

“We could easily see the 1.14 - 1.20 trading range for euro/dollar persist while US dollar/yen stays close to 160. Notwithstanding any initial slide in the US dollar once the war ends, the more likely direction seems to be some modest strength in the US dollar that test, and possibly breaks these levels”, said Steven Barrow.

With major currencies like the euro and yen seemingly stymied and volatility falling, it is little surprise that carry trade strategies have won out. “We expect that this strategy will continue to pay dividends and may undoubtedly work even better in the emerging market space. The Middle East conflict has not seen a surge in demand for the sort of safe-asset currencies like the US dollar, yen and Swiss franc that usually serve as the funding currencies for the carry trade”, emphasized Steven Barrow.

If investors can buy higher yielding currencies without fear of rapid losses from large rallies in safe asset currencies then it is likely to embolden carry traders. Of course, the yen is still a risk because of the BoJ intervention threat, while the US dollar is hardly a low-yielding currency right now. But, in spite of these issues, Steven Barrow still feels that the carry trade will perform well.