Escalation In The Middle East
The United States and Israel hit thousands of targets inside Iran during a joint campaign. The report said this followed the killing of Iran’s supreme leader, Ayatollah Ali Khamenei. Reuters cited Ebrahim Jabari, an adviser to the Islamic Revolutionary Guard Corps commander-in-chief, saying: “The Strait of Hormuz is closed.” He added that any ships attempting passage would be set ablaze by Revolutionary Guards and the regular navy. In US data, the ISM Manufacturing PMI eased to 52.4 in February from 52.6 in January, above the 51.8 forecast. The Manufacturing Employment Index rose to 48.8 from 48.1, remaining below 50. The dollar also drew support from expectations that higher energy prices could raise inflation and reduce the likelihood of near-term Federal Reserve rate cuts. Higher energy costs also weighed on currencies in major energy-importing economies, including Europe and Japan.Market Implications And Positioning
Looking back to early 2025, we saw the US Dollar Index surge as the conflict with Iran escalated and key shipping lanes were threatened. The flight to safety was immediate, driving the dollar higher as concerns over a wider war grew. This initial move was a clear signal of the market’s response to geopolitical instability in the Middle East. The closure of the Strait of Hormuz caused a massive energy price shock that rippled through the global economy for the rest of that year. Brent crude oil prices spiked to over $150 per barrel by June 2025, pushing US headline CPI inflation up to a painful 5.8% by the fourth quarter. This forced the Federal Reserve not only to scrap any plans for rate cuts but to implement two more hikes, bringing the Fed funds rate to its current 6.0% level. Today, the dollar’s dominance continues, with the DXY now firmly entrenched above the 105 level as high interest rates and safe-haven demand provide dual support. Currencies of major energy importers have suffered immensely, with the Japanese Yen weakening past 160 to the dollar. In Europe, persistently high energy costs have kept the Euro below parity with the USD for several months. Given this sustained trend, we should consider using call options on the UUP exchange-traded fund to maintain long exposure to the dollar while defining our risk. Continuing to buy puts on the Euro and Yen also makes sense, as their economies show little sign of overcoming the energy cost burden. These positions capitalize on the clear divergence in central bank policy and economic outlook. Volatility in the energy sector will remain extremely high, making it a difficult market for directional bets. A better approach is to trade the volatility itself by using long straddles or strangles on WTI crude oil futures. This strategy will profit from the large price swings that are likely to continue as long as tensions in the Middle East remain unresolved. The sustained high-rate environment has also put significant pressure on the stock market, with the S&P 500 having entered a bear market in late 2025. We should expect this pressure to persist as borrowing costs weigh on corporate earnings. Purchasing VIX call options or puts on major equity indices like the SPY remains a prudent hedge against further market declines in the coming weeks. Create your live VT Markets account and start trading now.
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