The war in Iran led to an energy price shock that has important implications for the US dollar, as we described in our recent currency strategy article: “How the Iran conflict could impact the US dollar in two phases.” While the initial oil price surge led to dollar strength, the outlook has now changed. With spot crude prices close to 40% below their recent peak, the global cycle should receive a boost, led by energy importers.

From a currency perspective, this stronger growth outlook should push us into the middle of the dollar smile framework (or smirk, if you subscribe to the view). In this framework, improving global growth is typically associated with a weakening dollar as capital flows into riskier markets seeking higher returns, especially when risk premia are low in the US.

An added kicker would be if global ex-US equity markets start to outperform the US. As this month’s chart shows, these periods of US equity market underperformance – highlighted as orange dots on the chart – tend to accelerate the draw of capital from the US as the global purchasing managers’ index improves. The recent correction suffered by the Magnificent Seven stocks has narrowed the performance gap, given the lower technology exposure of the MSCI World ex-US Index relative to the MSCI US Index (10.5% vs. 38.3%).