Dollar Weakens as Trump De-Escalation Narrows US-Europe Yield Gap, MUFG Reports

The US dollar extended its retreat on March 10, 2026, as President Trump's characterization of the Iran conflict as a "short-term excursion" eroded the safe-haven premium that had driven the DXY dollar index to 99.68 earlier in the week, its highest reading since November 2025. By Tuesday's close, the DXY had fallen to 98.70, shedding 0.48% on the session as currency markets recalibrated the expected duration and economic impact of the Middle East conflict [1].

MUFG Senior Currency Analyst Lee Hardman published the bank's FX Daily Snapshot on March 10, diagnosing the dollar's reversal as the product of two converging forces: Trump's de-escalation rhetoric and a yield differential shift that has favored European currencies over the greenback since the conflict began on February 28 [1].

The Yield Spread Story

At the heart of MUFG's analysis is a finding that caught many traders off guard: European short-term interest rates have risen more sharply than their US equivalents since the conflict erupted, narrowing the yield advantage that typically supports dollar strength during geopolitical crises.

The UK's outsized repricing was particularly notable. Two-year gilt yields peaked near 4.4% during Monday's oil spike before settling to 3.91% on March 10, still well above the pre-conflict level of 3.5%. Hardman attributed the divergence to the differing inflation sensitivities of each central bank [1].

"Market participants have taken the view that the ECB and BoE will be more sensitive to higher inflation given the policy rate in the euro area is already at neutral and inflation has proven more persistent in the UK. In contrast, the US rate market still expects the Fed to deliver 1-2 rate cuts this year with the US economy expected to see relatively smaller pick-up in inflation pressures from the energy price shock." [1]

The implication is counterintuitive: the energy shock, which initially strengthened the dollar through risk-off flows, is now working against it by forcing European central banks into a more hawkish posture relative to the Federal Reserve.

Dollar Forecast: DXY Toward 99, Then Lower

MUFG's updated forecasts call for the DXY to end Q1 2026 near 99.63, only modestly above current levels, before embarking on a sustained decline through the remainder of the year. The bank projects the index will fall to 94.06 by Q4 2026, reflecting its baseline assumption that the conflict will last weeks rather than months and that the energy shock will prove temporary [2].

"The timely comments from President Trump are perhaps an indication that the oil price spike was starting to become a bigger concern which could restrain the duration of the conflict. It is one of the reasons in our latest FX forecasts that we had assumed that the conflict was more likely to last weeks rather than months." [1]

"A temporary energy price shock would be less disruptive for the global economy, and could see the US dollar continuing to give back recent gains." [1]

Currency Pair Forecasts and March 10 Levels

EUR/USD traded near 1.1637 on March 10, above MUFG's end-of-Q1 target of 1.1500 but well below its year-end projection of 1.2300. MUFG's quarterly path envisions EUR/USD at 1.1800 by Q2 and 1.2100 by Q3, a trajectory that implies a steadily weakening dollar as the conflict premium fades [2].

Hardman flagged a cautionary precedent: when Russia invaded Ukraine in February 2022, EUR/USD fell from 1.1200 to 0.9500, a decline of roughly 15%. A similar move from current levels would push the pair below 1.00, though MUFG considers such an outcome unlikely given the bank's assumption of a shorter conflict duration [2].

Fed Pricing: Cuts Still on the Table

Despite the inflationary impulse from surging energy costs, the US rate market continues to price in one to two Federal Reserve rate cuts for 2026. MUFG's baseline scenario calls for three cuts that would bring the fed funds rate to or below neutral before the November midterm elections. That outlook could shift depending on the Senate confirmation hearings for Kevin Warsh, who has been nominated to succeed Jerome Powell as Fed Chair when Powell's term expires in May 2026 [2].

The divergence between Fed and ECB expectations is the key driver of MUFG's dollar-bearish view. The European Central Bank has held its policy rate at 2.00%, which MUFG characterizes as already at neutral, leaving the ECB with less room to absorb an energy-driven inflation shock without tightening. The Bank of England, at 3.75%, is in a similar bind; MUFG expects two further 25-basis-point cuts in Q2 and Q3, but only after Middle East risks recede [2].

China Trade Data: A Sidebar With Implications

MUFG's March 10 snapshot also highlighted fresh Chinese trade figures that underscore the shifting currents in global commerce. China's January-February combined exports rose 21.8% year-over-year, a sharp acceleration from December's 6.6% pace. Exports to the United States fell 11% over the same period, an improvement from December's 30% decline, following the Supreme Court's decision to strike down Trump's IEEPA tariffs as unconstitutional. Meanwhile, exports to ASEAN surged 29.5% and shipments to the EU jumped 27.8%, evidence of ongoing trade diversion [1].

The People's Bank of China set a stronger-than-expected daily fix slightly below 6.9000 for USD/CNY, reinforcing the managed weakening of the dollar against the yuan. The pair traded at 6.8699 on March 10, down 0.28% on the day [3].

The Week Ahead

ING's technical team noted in a March 8 analysis that "big support just below 1.1500 in EUR/USD remains vulnerable" and that "the longer energy prices stay high, the greater the damage to the 2026 narrative" of dollar weakness and European recovery [4]. With US CPI data due on March 11 and the IEA's emergency reserve-release discussions ongoing, currency traders face a week where both the geopolitical and macroeconomic calendars could deliver fresh volatility to a market already stretched by the most intense energy shock in years.

References

[1] MUFG Research, "FX Daily Snapshot, 10 March 2026," https://www.mufgresearch.com/fx/fx-daily-snapshot-10-march-2026/ [2] MUFG Research, "Monthly Foreign Exchange Outlook, March 2026," https://www.mufgresearch.com/fx/monthly-foreign-exchange-outlook-march-2026/ [3] Trading Economics, "United States Dollar," https://tradingeconomics.com/united-states/currency [4] ING via FXStreet, "EUR/USD support at 1.15 under pressure," https://www.fxstreet.com/news/eur-usd-support-at-115-under-pressure-ing-202603090823