Dollar surges to 2026 highs as Middle East conflict drives energy shock

The dollar extended its advance against the euro for a third consecutive session on Thursday, pushing the single currency to $1.1513, its weakest level since November, as a sharp escalation in Middle East hostilities sent energy markets into turmoil and laid bare the eurozone's enduring structural vulnerability to oil and gas supply shocks.

Iran's new Supreme Leader, Mojtaba Khamenei, vowed on Thursday to keep the Strait of Hormuz closed, a declaration that transformed what had been a simmering regional conflict into a direct threat to global energy flows. The strait carries roughly one-fifth of the world's petroleum liquids, and its closure, even partial, forces an immediate repricing of crude and refined products. Oil prices jumped sharply in response, with Brent crude climbing above $95 a barrel in early European trading, a level not seen since the early months of the Russia-Ukraine war.

The International Energy Agency moved quickly. On Wednesday, member countries agreed to release 400 million barrels from strategic stockpiles, a record volume that nonetheless covers only about 20 days of the supply lost through the Hormuz disruption. Physical delivery will take weeks or months to reach markets, leaving a near-term gap that financial markets are pricing aggressively. The IEA's emergency response underscores the severity of the supply shock but also its limitations: strategic reserves are a bridge, not a solution.

The eurozone imports more than 90% of its oil and a substantial share of its natural gas, a dependency that has only deepened since the 2022 energy crisis forced a hurried diversification away from Russian pipeline gas toward global liquefied natural gas markets. That diversification created new exposure to maritime chokepoints, Hormuz foremost among them. When the strait closes, the eurozone pays more for every unit of energy, widening its trade deficit and draining domestic purchasing power. The currency adjusts accordingly.

"The main thing that matters today is gas and oil, and the euro zone is quite exposed to these things. So you see the euro selling off across the board," said Lefteris Farmakis, a strategist at Barclays. The euro fell not only against the dollar but also against the Swiss franc and the Swedish krona, confirming the move is euro-specific rather than a broad dollar rally alone. Since the conflict erupted, the euro has lost 2% against the greenback, while the Korean won has dropped 3% and the Indian rupee and Japanese yen have each shed more than 1.5%, a ranking that maps neatly onto net energy import dependence.

The United States, by contrast, is a net energy exporter. Higher oil prices improve its terms of trade, support the current account, and reinforce the dollar's safe-haven bid. The dollar index (DXY) has risen more than 1.5% against a basket of major currencies since the escalation began, approaching its highest level since November. This dynamic, energy shock hurts importers, helps exporters, is a structural feature of the post-2010 global economy, but it has rarely been this stark. The dollar's gain is not merely a flight to safety; it is a reflection of a genuine shift in relative economic fundamentals.

Benjamin Ford, a researcher at macro strategy firm Macro Hive, put it bluntly: "A disappointing supply update from the International Energy Agency, and commitment from Supreme Leader Khamenei to keep the Strait of Hormuz closed is to blame." Ford expects EUR/USD to test 1.14, noting that foreign exchange markets are "trading the 2022 Russia-Ukraine game plan", a playbook that involves aggressive euro selling, dollar buying, and a sharp repricing of European growth expectations.

Risk appetite deteriorated further on Wednesday when the Trump administration launched a new trade investigation into excess industrial capacity across 16 major trading partners. The move, aimed at rebuilding tariff pressure after the US Supreme Court struck down the centrepiece of the administration's tariff programme last month, targets sectors where European and Asian producers compete directly with US manufacturers. The pound fell 0.5% to $1.3348, hovering just above its low for the year, while the dollar edged up 0.3% to 159.395 yen.

The investigation introduces a second channel of euro weakness: trade policy uncertainty. European exporters, already grappling with higher energy costs, now face the prospect of renewed US tariffs on steel, aluminium, chemicals and machinery. The timing compounds the damage, the eurozone's manufacturing sector has been in contraction for much of the past two years, and higher input costs combined with market access risk could delay any recovery.

Next week's policy meetings at the Federal Reserve and the European Central Bank have taken on outsized importance. The swaps market on Thursday showed traders pricing an ECB rate hike as early as June, a striking shift for a central bank that only recently was contemplating cuts. The Federal Reserve, meanwhile, is expected to hold the federal funds target range at 3.50-3.75%, with the first cut now pushed back to September from a previous expectation of July, according to data compiled by LSEG.

"With the FOMC set to keep the fed funds target range between 3.50% and 3.75% next week, the focus will be on any changes to the policy statement and new economic projections," said Stephen Brown, deputy chief North America economist at Capital Economics. "The most hawkish outcome would be if the Fed removed its easing bias from the statement, while the median projection shifted from one cut this year to no change." Such a shift would widen the interest rate differential in the dollar's favour, adding a monetary policy tailwind to the energy-driven fundamental move.

The ECB faces a more delicate calculus. An energy price shock is inherently stagflationary, it raises inflation while depressing growth. The ECB's mandate prioritises price stability, but hiking rates into a supply-driven inflation spike risks deepening a recession. Christine Lagarde and her colleagues have historically argued that monetary policy cannot solve supply shocks, but market pricing suggests traders doubt that restraint will hold if headline inflation re-accelerates. The June meeting is now a live decision.

The speed of the repricing across asset classes reveals a market that had grown complacent about geopolitical risk. Bitcoin, often viewed as a risk-on barometer, fell 1% to slip just below $70,000, though it remains well above the multi-year low of $60,008 touched in early February. European equity futures pointed to a lower open, with energy-intensive sectors, chemicals, steel, autos, leading the declines. Sovereign spreads widened modestly, with Italian 10-year yields rising five basis points relative to German bunds, a reminder that fiscal fragility remains a latent risk.

The critical unknown is duration. If the Hormuz closure persists for weeks, the IEA's 400 million barrel release becomes a temporary salve. If it persists for months, the eurozone faces a genuine terms-of-trade shock comparable to 2022, with all the attendant consequences for growth, inflation, and political stability. The dollar's ascent to 2026 highs is not a bet on American exceptionalism; it is a hedge against European exposure.

International Energy Agency · European Central Bank · Federal Reserve · Barclays · Capital Economics · Macro Hive

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