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"When the Bombs fall, the Dollar Rises": Pound-Dollar at Risk of Decline on Escalation in Middle East Tensions

Iran and impact on Pound-Dollar

Image © Azat Valeev, Adobe Stock

- Markets await Iranian aggression in Middle East

- Dollar seen going 4% higher in 2020

- Dollar benefits in times of confusion

- Herd mentality to drive Dollar demand

The U.S. Dollar is being tipped to benefit from rising geopolitical tensions between the U.S. and Iran, with one analyst saying 2020 should see the currency move higher by about 4%, partly as a result of market desire for safe-haven assets.

Jonas Goltermann, an analyst with Capital Economics, the independent economics research house, says, "both US Treasuries and the Dollar have started the year on the front foot as the escalation of tensions between the U.S. and Iran has prompted renewed safe-haven demand. While we think that Treasury yields are unlikely to move much in 2020, we expect the Dollar to continue to recover from its autumn slump."

Global stock markets and commodities were sent into a decline on Friday, January 03 after the U.S. killed leading Iranian military commander Qasem Soleimani and sparked a rapid increase in tensions in the Middle East. Global financial markets remain nervous as Iran has vowed to avenge the death, while U.S. President Donald Trump has stated the U.S. is ready to hit 52 Iranian targets in response to any Iranian retaliation.

The conditions for an escalation in geopolitical tensions are therefore in place.

"Unfortunately, the new decade has kick started with an escalation in US-Iran tensions, which has triggered risk-off market conditions. Geopolitics will therefore remain in the spotlight for the foreseeable future," says George Vessey, Currency Strategist at Western Union.

Ulrich Leuchtmann, Head of FX & Commodity Research at Commerzbank says "when the bombs fall, the Dollar rises."

Leuchtmann says it remains a fact that the Greenback remains a well-functioning safe haven for global investors when geopolitical risks are involved.

"When the bombs fall, investors push into the dollar," says Leuchtmann. "Those who are sophomoric may also question the logic behind this move. But what matters here is not so much geostrategic/economic mechanisms as the herd behaviour of those who know this reaction from the past and who, in a confusing environment, do what they know has worked well in the past: buy USD."

Dollar in decline

Above: The Dollar has been moving lower over recent months, but has picked up ground at the start of 2020 amidst rising geopolitical tensions.

"The strongest argument for the safe haven nature of the Dollar in phases of geostrategic risk is therefore: it is "safe haven" because it has always been safe haven in similar episodes in the past," adds Leuchtmann.

The Pound-to-Dollar exchange rate fell to a low of 1.3050 on Friday, while the Euro-to-Dollar exchange rate dipped to 1.1124. The declines are actually relatively modest when compared to moves in oil and equity markets, and suggest the for now foreign exchange markets are in a wait-and-see mode as they anticipate the next moves by the U.S. and Iran.

Regardlesss, it appears that for the coming week direction in the Dollar will largely be dictated by investor sentiment.

Safe-haven demand remains a key driver of both currency and bond markets notes Goltermann: "when tensions increased, investors bought government bonds and favoured the Dollar over riskier currencies."

It therefore stands that the Dollar, considered a safe-haven owing to its sheer volume, would benefit should tensions between Iran and the U.S. escalate.

But for Goltermann 2020 won't just be a story of geopolitical tensions, the U.S.-China trade war is expected to deliver Dollar strength.

"In our view tensions between the US and China are likely to remain high despite the recently agreed ‘phase-one’ deal, which should keep investors favouring bonds and the Dollar," says Goltermann.

"On balance, this suggests to us that the dollar will continue to appreciate against most currencies: we forecast the Dollar to rise by about 4% on a broad trade-weighted basis in 2020," says Goltermann.

A recovery in the Dollar would follow months of decline for the world's most liquid currency, which has been steadily losing value since October 2019. The Dollar index - a measure of broad-based Dollar value - peaked at 99.60 in October before declining to a low of 96.40 at the end of 2019.

2020 has seen the currency recover some lost ground, and the index is presently seen at 96.89.

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