Dollar sheds bulk of Iran war premium, but few expect a sharper drop

• The dollar index rose over 3% to a 10-month high of 100.64 during the U.S.-Iran conflict but has since retreated to 98.07, just 0.5% above pre-conflict levels, though analysts doubt it will break below this year's low of 95.55
• Foreign holdings of U.S. Treasuries rose to $9.305 trillion in January (up 8% year-over-year) as markets now price in at most one Fed rate cut in 2026, down from expectations of two cuts before the war
• The 2-year German-U.S. bond spread sits at 1.135 percentage points, above the 20-year median of 0.93 percentage points, maintaining a yield advantage for U.S. assets that supports the dollar despite geopolitical uncertainties

Summary: Dollar Sheds Iran War Premium But Expected to Remain Supported

The U.S. dollar has relinquished most gains generated by the Iran conflict as a tentative ceasefire improves risk appetite, but analysts expect limited downside due to strong structural support factors.

Key Market Movements:

• The dollar index surged over 3% to a 10-month high of 100.64 during the U.S.-Iran conflict
• Currently trading at 98.07, approximately 0.5% above pre-conflict levels
• The dollar had previously declined 11% in the first half of 2025 following President Trump's tariff policies and Federal Reserve criticism
• Year-to-date low stands at 95.55, which analysts believe will hold

Supporting Factors:

• Foreign demand remains robust: Foreign holdings of U.S. Treasuries rose to $9.305 trillion in January, up 8% year-over-year
• Rate differential advantage: The 2-year German-U.S. bond spread sits at 1.135 percentage points, above the 20-year median of 0.93 percentage points, maintaining U.S. yield attractiveness
• Limited Fed rate cuts: Markets now expect at most one rate cut in 2026, down from two previously, as war-driven oil price surges complicate inflation management
• Strong equity performance: The S&P 500 is approaching January record highs, attracting continued capital inflows

Market Outlook:

Analysts expect the dollar to remain range-bound over the next 6-9 months. While structural headwinds include fiscal concerns and current account deficits, robust U.S. asset demand and favorable interest rate differentials should prevent significant declines. Geopolitical risks persist with ongoing Strait of Hormuz shipping blockades potentially reigniting conflict.