• Fears that the Israel-Iran conflict escalates into a regional war are boosting risk aversion and supporting the USD.
  • Fed Powell's hawkish tone after the monetary policy decision provided an additional boost to the Dollar.
  • FX volatility might rise later today as liquidity declines wth US markets closed on the Juneteenth holiday.

The Dollar has recovered its safe-haven status amid fears that the Middle East conflict escalates into a regional war with the US intervention. The US Dollar Index (DXY), which measures the value of the Greenback against the world’s most traded currencies, extended gains for the fourth consecutive day, hitting session lows at 98.70 before pulling lower.

US President Trump left the world wondering whether the US will join Israel in its war against Iran, with an ambiguous message. Earlier on Thursday, Bloomberg reported that US senior officials are preparing for the possibility of a strike on Iran, which keeps markets on edge.

The Middle East conflict worsens with no end in sight

Meanwhile, Israel has pounded Iran’s Arak heavy water nuclear reactor, and Iranian missiles hit several sites in Central and Southern Israel, as the war enters its seventh day with no sign of an end in sight.

On Wednesday, the Federal Reserve held interest rates at the current 4.25%-4.50% range and maintained the projections of two more rate cuts in 2025. Chairman Powell, however, curbed investors’ optimism, warning about upcoming inflationary pressures, as the effect of tariffs filters in, and dampened hopes of any near-term rate cut.

The calendar is light today, with US markets closed for the Juneteenth bank holiday. Geopolitical tensions are likely to remain the main market driver, with liquidity declining during the US trading session, which may lead to volatility spikes. 

Risk sentiment FAQs

In the world of financial jargon the two widely used terms “risk-on” and “risk off'' refer to the level of risk that investors are willing to stomach during the period referenced. In a “risk-on” market, investors are optimistic about the future and more willing to buy risky assets. In a “risk-off” market investors start to ‘play it safe’ because they are worried about the future, and therefore buy less risky assets that are more certain of bringing a return, even if it is relatively modest.

Typically, during periods of “risk-on”, stock markets will rise, most commodities – except Gold – will also gain in value, since they benefit from a positive growth outlook. The currencies of nations that are heavy commodity exporters strengthen because of increased demand, and Cryptocurrencies rise. In a “risk-off” market, Bonds go up – especially major government Bonds – Gold shines, and safe-haven currencies such as the Japanese Yen, Swiss Franc and US Dollar all benefit.

The Australian Dollar (AUD), the Canadian Dollar (CAD), the New Zealand Dollar (NZD) and minor FX like the Ruble (RUB) and the South African Rand (ZAR), all tend to rise in markets that are “risk-on”. This is because the economies of these currencies are heavily reliant on commodity exports for growth, and commodities tend to rise in price during risk-on periods. This is because investors foresee greater demand for raw materials in the future due to heightened economic activity.

The major currencies that tend to rise during periods of “risk-off” are the US Dollar (USD), the Japanese Yen (JPY) and the Swiss Franc (CHF). The US Dollar, because it is the world’s reserve currency, and because in times of crisis investors buy US government debt, which is seen as safe because the largest economy in the world is unlikely to default. The Yen, from increased demand for Japanese government bonds, because a high proportion are held by domestic investors who are unlikely to dump them – even in a crisis. The Swiss Franc, because strict Swiss banking laws offer investors enhanced capital protection.

 


Source: Fxstreet