Does the Iran War Change Our View on the US Dollar

No, we continue to believe the US dollar faces meaningful downside risks over the next few years and recommend that investors remain underweight the dollar in portfolios. While the US dollar could appreciate further in the near term if the conflict in Iran intensifies and oil prices continue to rise, the situation in the Middle East remains too fluid to time tactically with confidence. As a result, we believe investors are better served by focusing on the dollar's elevated valuation and on diversifying portfolios that have become increasingly concentrated in USD assets over recent years.

As discussed in our 2026 Outlook, we expected the US dollar to stage a rebound at some point this year due to oversold conditions and its historical tendency to strengthen during risk-off episodes. While conflict with Iran was not the catalyst we anticipated, the recent move is consistent with that view. Even after appreciating roughly 4% since the conflict began, the dollar's rally still appears modest rather than overextended. If hostilities intensify further and oil prices continue to rise, the near-term bias for the US dollar may remain to the upside, particularly given the United States' position as a net oil exporter and the dollar's longstanding role as a defensive asset during periods of market stress.

That said, we do not view the current oil shock as the start of a lasting regime shift for currencies. Higher oil prices should weigh on the currencies of net oil-importing economies through a negative terms-of-trade shock, but our base case is that this pressure proves temporary rather than permanent. Even if the conflict persists, a sustained closure of the Strait of Hormuz appears unlikely, as the economic costs would rise quickly for all parties and intensify pressure to restore safe passage. Recent US messaging, including President Donald Trump's acknowledgment on Monday that peace talks with Iran are underway, reinforces our view that the United States does not want a prolonged conflict. In our assessment, that reluctance reflects not only geopolitical and economic considerations, but also the domestic political costs associated with higher oil prices and a prolonged foreign conflict ahead of the November US congressional elections.

If the conflict were to broaden into a more prolonged energy crisis, the dollar could also become a victim of its own success. A sufficiently large oil shock would eventually undermine global growth, weaken aggregate demand, and help bring energy prices back down, particularly if even modest additional supply also comes online. A much stronger dollar in a recessionary backdrop would likewise tighten financial conditions and increase pressure on the Federal Reserve to cut rates more aggressively or reintroduce balance-sheet support. History suggests that once the Fed shifts decisively toward easing in response to growth stress, earlier USD strength can give way to renewed weakness, as seen in 2001, 2008, and, to a lesser extent, 2020.

Stepping back, the more lasting consequence of the current crisis may be a further strengthening of policy priorities in many countries around energy security, grid resilience, renewables, nuclear power, and defense spending. These investment needs were already becoming more apparent and have been reinforced by electrification trends and the global artificial intelligence (AI) data center buildout, both of which are increasing demand for generation, transmission, and power equipment. While the United States has been the main beneficiary of AI- and semiconductor-related capital spending to date, a broader capex cycle centered on grids, power systems, energy security, and defense is likely to be more geographically dispersed and could provide greater support to non-US markets, which generally have deeper exposure to industrials, utilities, and related cyclicals. The conflict may also reinforce concerns among some non-US investors about the prudence of maintaining large exposures to US assets, potentially reducing the marginal flow of foreign capital into US markets relative to recent years.

Taken together, these dynamics reinforce our broader view that the US dollar remains vulnerable over the next few years, even if it strengthens further in the near term. The dollar remains overvalued in our view and continues to be supported by concentrated flows into US equities, particularly large-cap technology stocks. If market leadership broadens from US tech toward cyclicals and non-US equities, downside risks to the dollar could become more pronounced. Rather than chasing short-term USD strength, we think investors are better served by focusing on diversification and using periods of dollar appreciation as opportunities to initiate or add to USD underweights across portfolios.