Barclays: The rebound of the US dollar is a "bitter victory"; a relaxation in geopolitical tensions will trigger a pullback.
Barclays Bank believes that for bulls, the recent strength of the US dollar may look like a feast, but it is merely a "bitter victory."
According to Zhui Feng Trading Desk, a Barclays Research Team report on March 24 pointed out, the energy price shock triggered by the escalation of tensions in the Middle East has indeed boosted the dollar, but the USD’s continued underperformance relative to interest rate differentials shows that a "5% USD risk premium" is already deeply entrenched and difficult to dissipate.
Once the situation in the Middle East stabilizes and energy prices fall back in the coming months, the dollar will face inevitable short-term weakness and correction.
The US Dollar is Strong, but Not Strong Enough
Barclays’ report states that after the Middle East Iran conflict broke out, the dollar demonstrated its traditional advantages: energy independence, technological leadership, and economic resilience.
Data shows that for every 10% rise in oil prices, the dollar appreciates about 0.5%–1% against major currencies such as the euro and pound.
(When oil prices rise by 10%, the US dollar exchange rate increases by 0.5%–1%)
However, the dollar’s performance still lags well behind traditional benchmark indicators such as interest rate differentials. Taking EUR/USD as an example, the fair value based on the 10-year real interest rate differential is around 1.10, but the actual exchange rate is trading near 1.15.
(Lagging behind the trend of interest rate differential changes)
The core reason for this divergence lies in a persistent and sizable "USD premium" of about 5%. This premium has lingered near the 1-sigma threshold for more than a year, well above historical norms.
(USD premium status)
The report defines "USD premium" as: the actual level of EUR/USD, subtracted from "fair value" calculated based on factors such as the 10-year real interest rate differential and relative stock performance (MSCI US/Europe ratio).
Specifically, the report quantifies this premium through a regression model. The model regresses EURUSD against the variables above; the "USD premium" is the residual of this regression model.
What supports this premium? Barclays believes it is increasingly and highly correlated with US-specific risk factors: firstly, economic policy uncertainty within the US, and secondly, valuation fluctuations of the US technology sector.
This premium did not dissipate during the escalation of the Iran conflict, meaning investors who are long the dollar are actually bearing extremely high and unpredictable policy communication risk.
Structural Factors Are Reshaping US Dollar Logic
In the past, when global risks rose, the dollar benefited from its safe-haven attributes and the premium was often negative—that is, the dollar was more expensive.
But since 2025, the situation reversed. Uncertainty around US domestic economic policy has surged and has become positively correlated with the dollar premium. The market has begun to demand compensation for "domestic policy risk" when holding US dollars.
(Premium levels reflect policy risks unique to the US)
Another driving factor is tech stocks. Previously, rising US tech stocks symbolized "American exceptionalism" and were bullish for the dollar. But now, market worries about AI disruption could make tech rallies negatively correlated with the USD premium, weakening the dollar’s appeal.
(Impact of the tech sector)
Near-Term USD Outlook: Soft Landing, But No Crash
On this basis, Barclays gives a balanced outlook for the dollar. Currently, the dollar is supported by high oil prices and geopolitical risks. But if the premium does not disappear even in periods favorable for the dollar, it is highly likely to persist when conditions ease.
Therefore, assuming the conflict eases in some form within the next quarter and oil prices drop, the dollar will face downside pressure. Meanwhile, the US domestic agenda, such as midterm elections and the prospect of a new Federal Reserve chair, may keep the premium elevated.
However, thanks to AI-related capital expenditure and fiscal tailwinds, the resilience of the US economy should prevent a crash in the dollar.
But by early next year, the market may begin to focus on fiscal gridlock that may emerge after midterm elections. If new fiscal stimulus cannot be passed, expectations for growth in the last two years of the Trump administration may cool.
All in all, Barclays analysts expect that for quite some time ahead, EUR/USD will fluctuate within the range established since last April.
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The above highlights are from Zhufeng Trading Desk.
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