Middle East Escalation Drives Risk Off
A US and Israeli attack killed Iran’s Ayatollah Ali Khamenei on Saturday. Iran then hit US bases in Gulf state countries and fired a missile at a UK airbase in Cyprus. US data showed manufacturing held up. The ISM Manufacturing PMI for February was 52.4, down from 52.6, staying in expansion for a second month. The ISM Prices Paid index rose from 59 in January to 70.5. This was the highest level since October 2022, a three-and-a-half-year high. Markets shifted expected US rate cuts from 60 basis points to 48 basis points. The US Dollar Index rose 0.83% to 98.45.Key Central Bank Speakers Ahead
RBA Governor Michele Bullock is due to speak on Tuesday. Fed officials John Williams and Jeffrey Schmid are also due to speak. AUD/USD support is near 0.7090, then 0.7050 and 0.7000, with resistance near 0.7125 and 0.7170. A close above 0.7170 targets 0.7250. Looking back at the events of 2025, we saw the AUD/USD pair drop to around 0.7083 following the escalation of conflict in the Middle East. Today, on March 3rd, 2026, the situation has evolved, with the pair trading significantly lower near 0.6550. The intense flight-to-safety from last year has subsided, but the market dynamics have fundamentally shifted since then. A year ago, markets were pricing in nearly 50 basis points of Federal Reserve rate cuts, but persistent inflation kept the Fed on hold for much longer than anticipated. The US Dollar Index (DXY) reflects this reality, holding strong around 104.5, a considerable difference from the 98.45 level seen during the 2025 turmoil. This sustained dollar strength remains the primary headwind for the AUD/USD. The spike in oil prices during the 2025 conflict has moderated, with WTI crude now trading near $82 per barrel, down from the peaks but still at a level that adds to global inflationary pressures. While the direct military threat has de-escalated, we see that underlying tensions continue to simmer, representing a background risk. This keeps a floor under haven currencies like the US dollar. Australia’s key export, iron ore, has also softened, with prices now hovering around $110 per tonne amid ongoing concerns about China’s property sector and overall industrial demand. This is a change from the more robust commodity environment that supported the Aussie dollar in the past. We must factor this commodity weakness into our outlook. Given this backdrop, we should consider buying put options on the AUD/USD to protect against further downside. A put option with a strike price around 0.6400 could offer a cost-effective hedge if US economic data continues to outperform or if risk aversion returns. This strategy allows for participation in a further decline while capping the initial risk. Implied volatility in AUD/USD has decreased since the highs of the 2025 conflict, and we believe it may be underpricing the risk of renewed market stress. Therefore, establishing long volatility positions, like a long strangle, could be advantageous. This would profit from a significant move in either direction, which is plausible given the uncertain outlook for both global growth and central bank policy in the coming weeks. Create your live VT Markets account and start trading now.
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