USD: Energy shock drives brief rebound – MUFG

MUFG’s Lee Hardman notes that the Dollar has rebounded sharply as Operation “Epic Fury” triggers a fresh energy price shock, pushing the Dollar index back toward the 96.000–100.00 range. The move is supported by negative terms of trade for Europe and Asia, reduced Fed rate‑cut expectations, and a squeeze in short‑USD positions, but MUFG still expects USD strength to fade from Q2 2026.

Energy shock lifts Dollar but temporarily

"The USD has staged a strong rebound at the start of this week, driven by heightened geopolitical risks in the Middle East. The rally has already helped the dollar index fully reverse the losses recorded earlier this year, and it is now likely to test the upper end of the 96.000 to 100.00 trading range that has been in place since Q2 of last year."

"There are three main channels through which the USD stands to strengthen. First, economies in Asia and Europe will experience a larger negative terms of trade shock from higher energy prices than the United States."

"Secondly, higher energy prices are prompting US rate market participants to scale back expectations for further Fed rate cuts this year which is an assumption that had previously underpinned forecasts for USD weakness prior to Operation “Epic Fury.” This shift has reinforced market expectations that the Fed will leave rates on hold during the first half of the year."

"Thirdly, the USD could receive additional support from a shake‑out of crowded market positions. The latest IMM report shows that leveraged funds have been building up short USD positions since the start of this year, reaching their highest level since March 2022. These short positions are now being squeezed, reinforcing upward momentum in the USD."

"However, we expect the USD rebound to prove short‑lived. Our latest forecasts are based on the assumption that Operation “Epic Fury” lasts weeks rather than months."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)