A recent escalation in the Middle East, specifically the Iran conflict that began in late February with coordinated U.S. and Israeli strikes and Iran's closure of the Strait of Hormuz, has sent oil prices soaring above $100 per barrel, triggering significant volatility and policy reassessment across global currency and energy markets [1][2][3][4]. Europe, heavily reliant on imported energy, now faces renewed inflationary pressures, prompting markets to price in a roughly 70% probability of two 25-basis-point rate hikes by the European Central Bank (ECB) by year-end, with the first hike fully priced for July [1]. This marks a dramatic shift from near-zero expectations for ECB hikes prior to the conflict [1].
In contrast, the U.S. Federal Reserve is expected to keep its benchmark rate at 3.5–3.75% during its upcoming decision, with market expectations for rate cuts in June and September now largely pushed back. Traders now see at best one cut, possibly in December, as U.S. inflation remains above target at 2.4% in February and higher oil prices add further upside risk [1][2][3]. The U.S. Dollar Index (DXY) has pulled back from the 100 mark to trade near 99.80, reversing a four-day positive streak as markets digest the implications of the conflict and await central bank decisions [2][4].
Despite the setup for policy divergence, with the ECB potentially hiking and the Fed on hold, the euro has weakened sharply, dropping from above $1.20 to near $1.15 since the conflict began, making it the worst-performing major currency in this period according to Bloomberg [1]. EUR/USD is currently trading near 1.1500, breaking a four-day losing streak as traders reposition ahead of the ECB and Fed meetings, both of which are widely expected to keep rates unchanged this week [2].
The Swiss Franc has strengthened against the U.S. Dollar and other majors, reflecting its safe-haven status amid geopolitical uncertainty, while the U.S. Dollar has remained resilient due to its reserve currency role and support from higher oil prices [3]. The Swiss National Bank (SNB) is also expected to keep rates at 0%, with policymakers likely to rely on foreign-exchange intervention rather than negative rates to counter excessive franc strength [3].
Elsewhere, the New Zealand Dollar rebounded strongly, supported by robust Chinese economic data and expectations for a possible Reserve Bank of New Zealand (RBNZ) rate hike later in the year. The NZD/USD rose 1.42% on the day, with the U.S. Dollar weakening against most major peers as risk sentiment improved and concerns about Middle East supply disruptions eased slightly [4].
Forward-looking statements from the sources indicate that investors are closely watching the upcoming central bank meetings for guidance on how policymakers will balance persistent inflation risks against potential downside risks in the labor market, with particular attention on Fed Chair Jerome Powell's remarks [3]. Markets remain cautious, with expectations for further policy tightening in Europe and New Zealand, and a more hawkish or cautious tone from several major central banks in response to elevated oil prices and inflation [1][3][4].
CONCLUSION
The recent Middle East conflict and resulting oil price surge have upended market expectations, driving a sharp policy divergence between the ECB and the Fed and causing significant volatility in major currency pairs. Despite expectations for ECB rate hikes, the euro has weakened, while the U.S. Dollar and Swiss Franc have shown resilience. Investors are now focused on upcoming central bank decisions for further guidance amid persistent inflation and geopolitical uncertainty.