The U.S. dollar has erased all its wartime gains as markets bet on a Middle East de-escalation, but a resilient U.S. economy and a faltering Chinese trade surplus present a complex picture for the currency's future.
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Dollar's 3% War Premium Evaporates as Iran Peace Hopes Grow
A wave of optimism over a potential end to the Iran war has erased the dollar's entire 3% risk premium gained since the conflict began, pushing the DXY index back to pre-war lows and fueling speculation of a broader decline.
"Whether a trapdoor now opens beneath the dollar if the war ends and the Strait of Hormuz reopens is now a central question for global markets," Mike Dolan, a columnist for Reuters, said.
The DXY index, which tracks the dollar against six major currencies, has fallen from its peak, while the greenback has touched a three-year low against China's offshore yuan. This reversal comes as markets re-evaluate central bank policies, with two potential Federal Reserve rate cuts, previously priced out due to the conflict's inflationary impact, now back in focus.
The dollar's fate now hinges on three competing forces: a potential Fed pivot toward easing, China's strategic push to use its yuan for oil trade, and the powerful magnet of a U.S. stock market whose profit forecasts are outpacing Europe's by 10 percentage points.
The Petrodollar's Geopolitical Test
The dollar's recent vulnerability puts a spotlight on the decades-old "petrodollar" system, an arrangement foundational to the dollar's status as the world's reserve currency. Established in the 1970s, the system involves oil-producing nations, led by Saudi Arabia, pricing their exports in U.S. dollars and investing the proceeds into U.S. Treasury bonds in exchange for security guarantees.
The war in Iran is testing this regime. As the conflict drove oil prices higher, it also reinforced the dollar's safe-haven status. However, a potential peace deal threatens to unwind this dynamic. Concurrently, China is actively working to chip away at the petrodollar's dominance. Iran has reportedly begun accepting Chinese yuan for some passage tolls through the Strait of Hormuz, a symbolic but significant move in challenging the dollar's hegemony in oil transactions.
China's Shrinking Surplus Adds New Wrinkle
While China's currency has been a primary beneficiary of the dollar's recent weakness—appreciating over 2% against it this year—new data introduces a significant variable. China's trade surplus, a key driver of the yuan's strength, unexpectedly declined 4.7% in the first quarter of 2026.
According to Chinese customs data, imports surged 19.6% in the quarter, far outpacing export growth of 11.9%. This shift, driven by strong domestic demand for components and a policy push to expand imports, could weaken a key pillar of support for the yuan. A less robust yuan could, in turn, provide a floor for the U.S. dollar, complicating the bearish outlook even if a peace deal materializes. The market's perception of this shift—whether as a sign of healthy domestic rebalancing or weakening external competitiveness—will be crucial for the yuan-dollar exchange rate moving forward.
This article is for informational purposes only and does not constitute investment advice.
[1] How the Middle East War Affects the RMB Exchange Rate Trend[2] Dollar on defensive as markets hope for best on Middle East[3] Trapdoor creaks for dollar if Iran war ends[4] How the petrodollar regime came to be, and what losing it would mean for the U.S.[5] War and Energy Shortages Boost China’s Influence in Asia
