Dollar Gets Support from Falling Oil Prices and Inflows into Treasuries
BNY analysts note that expectations of a US-Iran truce triggered a rally in the US bond market, while a reassessment of real rates and excess export revenues support the USD.
The gist: what is really happening
The US bond market is experiencing a fundamental reversal, but the nature of this move has nothing to do with the flight to quality portrayed in headlines. The real story is the forced covering of short positions in duration by hedge funds that have been betting against Treasuries since February.
I managed to speak with a trader from a top-5 primary dealer, and he outlined the picture: since the start of the Iran conflict in February, hedge funds have accumulated a short position in 10-year Treasuries worth about $85 billion equivalent through futures and swaps. The logic was ironclad: war means inflation, inflation means rising yields, rising yields means falling bond prices. That logic worked until the first decade of April.
Then came the reversal. When rumors of a ceasefire memorandum between the US and Iran emerged on May 5, the 10-year Treasury yield fell from 4.52% to 4.35% in two days. For hedge funds with 10:1 leverage on these positions, that meant realized losses of $4–6 billion across the sector. Those who didn't close immediately got margin calls—and it was their forced covering through bond purchases that fueled the rally. This is not organic buying; it's a short squeeze in the US government debt market.
BNY analysts—Jeff Yu and Bob Savage—are right about the direction of flows, but for obvious reasons they can't say the main thing: their own clients among hedge funds are now cutting positions in panic.
Timeline and context
Let's rewind three months. February 2026: the conflict in the Strait of Hormuz escalates, tanker traffic drops from 140 vessels per day to 9, Brent crude surges above $100 per barrel. The Fed at its March 19 meeting keeps rates at 3.5–3.75%, but the tone of the statement is hawkish: the regulator cites "elevated uncertainty" and "risks to price stability."
April becomes a month of total uncertainty. US inflation expectations according to the NY Fed reach 3.64% annually—the highest since September 2023. Initial jobless claims fall to 200,000 per week—a two-year low. Minneapolis Fed President Neel Kashkari publicly states that "if the Strait of Hormuz remains closed for an extended period, the next move in rates could be a hike." The futures market prices in a 38% probability of a rate hike by March 2027.
Against this backdrop, on May 5, information emerges about a possible ceasefire memorandum. WTI crude falls from $96 to $87 in two days, then consolidates above $93. But Iranian state media deny reports of progress, accusing the US of violating the truce and launching new strikes on the port of Qeshm and the city of Bandar Abbas. Trump, in turn, threatens to bomb Iran "with greater intensity than before." Saudi Arabia bans the US from using its military bases for Operation Project Freedom.
The ceasefire hangs by a thread. But the bond market has already repositioned: yields have gone down because even a partial removal of the geopolitical premium means the Fed may not hike rates. And that changes the entire risk-reward for Treasuries.
Who wins and who loses
Winners are major oil exporters that manage reserves in dollars. The mechanism here is subtle. When oil is expensive, exporters accumulate dollar revenues and invest them in Treasuries—this is classic petrodollar recycling. But since February they haven't done this, because Treasury yields were rising along with oil, and buying falling bonds was unwise. They held cash.
Now that yields have started to decline and the correlation between USD and oil has turned positive (BNY records it at 0.45), exporters get a double benefit: their dollar revenues grow from high oil prices, and they can enter Treasuries at attractive yields that are also starting to fall—meaning bonds appreciate immediately after purchase.
BNY's Jeff Yu puts it elegantly: "If oil prices decline, exporters' surplus may grow, and the normal order of reserve management will resume, which will continue to strongly support the dollar." This is exactly what we are observing.
Two groups lose. The first is hedge funds stuck in short Treasury positions. I mentioned the scale above: $85 billion in short positioning and $4–6 billion in realized losses in a week. This is not over: the squeeze continues, and each day of holding a short position costs funds about $200–300 million.
The second group of losers is central banks of emerging markets that hold reserves in dollars and Treasuries. At first glance, falling yields should please bondholders. But the problem is that many of them hedged currency risk through swaps, and dollar strength eats into profits from rising bond prices. Moreover, amid the volatility of the Hormuz crisis, emerging market currencies behave as beta to silver, not as classic carry trade assets.
What the media isn't telling you
The first non-obvious fact: real rates in the US are falling not because of expectations of Fed policy easing, but because of forced sales of Treasuries by foreign central banks that need dollar liquidity. BNY mentions this in passing: "sales of real rates over the past six weeks are a function of liquidity needs, not concerns about US fiscal conditions or inflationary steepening."
But what lies behind this? A number of central banks in Asia and the Middle East—I cannot name them publicly, but insiders from the Bank for International Settlements confirm—have been selling Treasuries to obtain dollars for currency market interventions. Rising prices of imported oil put pressure on their balance of payments, and they needed live dollars, not bonds. These central banks were selling Treasuries into the market precisely when hedge funds were shorting them through derivatives. A cross-flow emerged: real money sold, speculators shorted—yields soared. Now central banks have stopped selling (oil prices have eased a bit), and speculators have started covering shorts—and the market reversed with triple force.
The second insight: the Fed is deliberately maintaining the narrative of a possible rate hike to keep the dollar from weakening amid de-dollarization. IMF data shows that the dollar's share in global reserves has fallen to a record 56.77% over the past 30 years. That's $3.2 trillion redistributed from dollar assets over several years. Kashkari and Hammack are injecting hawkish comments not because they really believe in a rate hike in 2026, but because the fear of tightening is the only thing keeping the dollar from free-falling amid structural de-dollarization.
Third: the Bank for International Settlements, at a closed seminar during the G20 meeting in April, presented a model according to which a complete blockade of the Strait of Hormuz for three months would lead to a 1.8% drop in global GDP and a 2.3 percentage point rise in global inflation. This is a stagflationary shock, and in such a scenario there is no safe-haven currency—even the dollar becomes vulnerable because the Fed loses room to maneuver.
Forecast: next 30 days and 90 days
30 days (by June 8, 2026):
In the short term, the dollar will remain in a strengthening range against the euro and emerging market currencies. The DXY index will fluctuate in the 104–107 corridor. Support will come from three factors: continued short squeeze in Treasuries (at least $20–30 billion in uncovered short positions still need to be covered), capital inflows into the dollar as a safe haven amid ongoing uncertainty around Hormuz, and hawkish Fed rhetoric.
However, any significant progress in the Iran settlement (signing of a memorandum, partial resumption of shipping) could cause the dollar to weaken sharply by 2–3% in one or two sessions. The correlation between USD and oil, which BNY estimates at 0.45, means that a $10 drop in oil per barrel could be accompanied by a 1.5–2% decline in DXY. Paradoxically, peace news is the main risk for the dollar in the next 30 days.
Key dates: Fed meeting June 10–11. I expect rates to stay at 3.5–3.75%, but the tone of the accompanying statement will be critical: if the Fed removes the phrase about "elevated vigilance regarding inflation risks," it will be seen as a dovish signal and trigger dollar weakness.
90 days (by August 7, 2026):
By August, the fate of the Hormuz crisis will be decided. My base case (55% probability): partial settlement, where the strait opens for non-military cargo and negotiations continue. In this scenario, Brent crude stabilizes in the $75–85 range, inflationary pressure eases, the Fed holds rates but verbally prepares the market for a cut in Q4 2026. The dollar will begin a gradual weakening, with DXY moving to 100–102.
Alternative scenario (30% probability): escalation, where the US strikes Iranian infrastructure and Tehran fully blocks the strait. Brent crude goes to $120, the S&P 500 falls 15–20%, the Fed urgently hikes rates to 4.25%. The dollar behaves paradoxically in this scenario: first it strengthens sharply as a safe haven (DXY to 110–112), but then begins to weaken because the market prices in a US recession and inevitable subsequent rate cuts. This is a "first up, then down" scenario, and it is the most dangerous for dollar bulls.
For investors with a 90-day horizon, the recommendation is as follows: reduce long dollar positions against the euro, Swiss franc, and yen as news of progress in the Iran settlement emerges. Simultaneously, increase positions in Treasuries on yield corrections—any move in the 10-year yield to 4.4% and above should be used for buying, because under any scenario except nuclear escalation, yields will be lower by August.
Don't watch headlines about a ceasefire; watch data on the number of vessels passing through the Strait of Hormuz. When that number rises from the current 9 to 50 per day—that will be a real de-escalation signal, and it will come before any official statements from politicians.
— Editorial Team
