Epic Fury Sends Markets Reeling: A New Energy Shock Ignites USD Surge
- Operation “Epic Fury” has triggered a sharp energy price shock and a strong USD rebound, with the dollar index reversing early year losses as geopolitical risks surged following extensive US‑led strikes on Iran and a wider regional escalation.
- Iran’s leadership vacuum and intensified retaliation raise uncertainty, with the killing of Supreme Leader Khamenei leading to an Interim Leadership Council and Iran launching widespread missile, drone, and proxy attacks which are far broader than during the June 2025 “Midnight Hammer” episode.
- USD strength is being reinforced by global terms of trade shocks, scaled‑back Fed rate cut expectations, and a squeeze in crowded short‑USD and FX carry positions, while high‑yielding EM currencies fall. The JPY could also benefit from carry‑trade unwinds despite BoJ caution.
- However, we expect the USD rebound to prove short-lived as the energy price shocks begins to fade, and heightened US policy uncertainty remains a headwind.
Middle East conflict delivering another energy price shock
The USD has staged a strong rebound at the start of this week, driven by heightened geopolitical risks in the Middle East. The rally has already helped the dollar index fully reverse the losses recorded earlier this year, and it is now likely to test the upper end of the 96.000 to 100.00 trading range that has been in place since Q2 of last year. The USD’s rebound has been triggered by President Trump’s decision to launch the military operation “Epic Fury” against Iran on 28th February. The main stated objectives of the operation are to: (i) eliminate Iran’s ballistic missile and nuclear threats; (ii) dismantle core elements of the Iranian regime’s security apparatus; (iii) neutralise key leadership figures; (iv) reduce Iran’s capacity to support proxy groups across the region; and (v) prevent future large‑scale missile and drone attacks on the US and allied states. President Trump has indicated that the operation is likely to last “four to five weeks,” though he emphasised that the US has the capability to continue for longer if necessary. The scale of Iranian retaliation and the potential for broader regional escalation could extend the timeline
Change in Iranian leadership creates fresh regional uncertainty
It is still early days, but the operation has already achieved notable successes, including the killing of Iran’s Supreme Leader Ali Khamenei, which has created a temporary leadership vacuum. While regime change is not formally an objective of Operation “Epic Fury,” President Trump has repeatedly called on the people of Iran to seize the opportunity to overthrow the government. So far, however, there is little evidence of a public uprising. According to the most recent verified information, following the death of Supreme Leader Ayatollah Ali Khamenei, an Interim Leadership Council has assumed control of Iran’s leadership. This council is serving as a temporary collective authority overseeing political and military decision‑making during the ongoing conflict. It is likely to include Iran’s president, the chief justice, a senior member of the Assembly of Experts, and representatives from the Islamic Revolutionary Guard Corps (IRGC). Iran may not choose a new Supreme Leader until the conflict stabilizes.
Operation “Epic Fury” to be more disruptive than “Midnight Hammer”
In comparison to Operation “Midnight Hammer,” which was the previous US military action in June 2025, Operation “Epic Fury” has far broader strategic aims. Operation “Midnight Hammer” was limited to targeting just three nuclear sites: Fordow, Natanz, and Isfahan, in order to destroy or severely damage Iran’s nuclear enrichment capabilities. The US strike itself took place on 22nd June as part of the 12‑day conflict. By contrast, Operation “Epic Fury” had already hit almost 2,000 targets within the first 48 hours, including government compounds, missile bases, military bases, IRGC sites, and leadership facilities.
Iran’s retaliation to be more disruptive as well
Similarly, Iran’s retaliation in response to Operation “Epic Fury” has been far larger, broader, and more destructive. In June 2025, Iran targeted only a small number of US military bases and avoided escalating the confrontation into a regional war. By contrast, in response to Operation “Epic Fury,” Iran has already launched waves of ballistic missiles and drones against US military bases in Bahrain, Qatar, the UAE, Kuwait, and Saudi Arabia. Fuel infrastructure has been hit at Oman’s Duqm port, Iran has threatened to target vessels transiting the Strait of Hormuz with the IRGC declaring its intent to enforce a closure, and Tehran has activated its regional proxy network.
Energy prices have already risen significantly to reflect supply disruption risks
The heightened risk of further retaliatory attacks from Iran, that could significantly disrupt the flow of energy from the Middle East, has the potential to trigger a much larger market reaction during Operation “Epic Fury.” Brent crude has already jumped to a high of USD 85.12 per barrel, extending its advance since the start of the year to almost 40%. By comparison, during the June 2025 episode, Brent rose by just over 25% at its peak. The surge in European natural gas prices has been even more pronounced, climbing nearly 80% so far this week to around EUR 57 per MWh. Even so, this remains modest relative to the extreme levels reached in 2022, when prices spiked as high as EUR 343 per MWh following Russia’s invasion of Ukraine.
Qatar has already shut LNG production
Gas prices jumped after Qatar shut LNG production at the world’s largest export facility following an Iranian drone attack. QatarEnergy’s Ras Laffan plant accounts for about one‑fifth of global LNG supply. China and India are the largest importers of Qatari LNG, followed by Taiwan, Pakistan, and South Korea. Europe receives only around 10% of its LNG from Qatar, although for Italy the share rises to roughly one‑third. Even so, the loss of Qatari LNG will intensify global competition for available cargoes, with Asian buyers likely to move quickly to replace lost volumes. The US is now the world’s largest LNG exporter and stands to benefit from the disruption. US LNG exports are largely contracted on a “free‑on‑board” basis making it easier to redirect shipments to the highest‑priced markets.
OIL PRICE SHOCK COMPARISON TO 2022
Source: Bloomberg, Macrobond & MUFG GMR
EUROPEAN NATURAL GAS COMPARISON TO 2022
Source: Bloomberg, Macrobond & MUFG GMR
Strait of Hormuz is effectively closed
At the same time, market participants are increasingly concerned about the risk of a prolonged closure of the Strait of Hormuz, a critical artery for the global economy. The Strait handles roughly one‑fifth of all globally traded oil, including exports from Saudi Arabia, the UAE, Kuwait, Iraq, Qatar, and Iran, with more than 17–20 million barrels per day normally passing through. This week, the Strait has been effectively closed, with the vast majority of commercial vessels halted, rerouted, or anchored. It has prompted President Trump to provide reassurance that the US will ensure the free flow of energy with insurance guarantees and even naval escorts. Trump’s proposed solution involves tapping the US International Development Finance Corporation (IDFC), which typically helps the private sector to provide finance for developing countries, to provide support for charterers, shipowners and maritime insurers. However, the exact details of any support remains unclear as does the timing.
Energy price shock triggers temporary USD rebound
Energy price shock has triggered a strong USD rebound, but are not expecting it to be sustained beyond near-term.
The energy price shock is spilling over into the foreign exchange market. The USD is benefitting from higher energy prices, similar to the last major negative price shock in 2022 following Russia’s invasion of Ukraine. At that time, the dollar index strengthened sharply when it rose by around 20% between February and September 2022 as oil prices jumped higher by roughly 80% and European natural gas prices surged higher by around 330%. The Ukraine conflict delivered a permanent negative energy supply shock to the global economy, hitting Europe hardest since Russian supply has not returned and has had to be replaced from alternative sources. In the current episode, the negative energy supply shock from the Middle East is likely to prove temporary, with supply expected to return once the conflict fades. However, there is significant uncertainty surrounding both the degree of disruption and its duration. A larger and more prolonged hit to global oil supply would trigger a correspondingly bigger market reaction.
Negative terms of trade shock to hit Asian and European economies harder than US.
There are three main channels through which the USD stands to strengthen. First, economies in Asia and Europe will experience a larger negative terms of trade shock from higher energy prices than the United States. The US has been a net energy exporter since 2019, according to the US Energy Information Administration (EIA), supported by record production of crude oil, natural gas, LNG, and refined petroleum products. In contrast, both Asia and Europe are net energy‑importing regions that are heavily reliant on external suppliers. The sharp deterioration in Europe’s terms of trade relative to the US was a key factor behind EUR/USD briefly falling below parity in 2022.
PERFORMANCE OF G10 FX VS. USD IN 2022
Source: Bloomberg, Macrobond & MUFG GMR
FX & US RATES VOL PICKED UP IN 2022
Source: Bloomberg, Macrobond & MUFG
Fed rate cut expectations have been scaled back but not pricing in hiking cycle like in 2022.
Secondly, higher energy prices are prompting US rate market participants to scale back expectations for further Fed rate cuts this year which is an assumption that had previously underpinned forecasts for USD weakness prior to Operation “Epic Fury.” This shift has reinforced market expectations that the Fed will leave rates on hold during the first half of the year. However, we do not expect the Fed to deliver aggressive rate hikes as it did in 2022, when rapid tightening helped fuel outsized gains in the USD. The Fed’s tightening cycle began in March 2022, shortly after Russia’s invasion of Ukraine, and resulted in a total of 4.25 percentage points of rate increases that year. With US rates now much closer to restrictive territory, there is less immediate pressure on the Fed to respond with additional hikes in 2026. Among the G10 central banks, the RBA is leading the way, having already raised rates once this year. It is now more likely to follow up with another near‑term hike in response to higher energy prices. Widening yield differentials and rising commodity prices have both been supportive of a stronger AUD.
Vol shock is triggering position liquidation as well offering support for USD & potentially JPY. High yielding EM FX are taking a hit as carry trades unwind.
Thirdly, the USD could receive additional support from a shake‑out of crowded market positions. The latest IMM report shows that leveraged funds have been building up short USD positions since the start of this year, reaching their highest level since March 2022. These short positions are now being squeezed, reinforcing upward momentum in the USD. At the same time, popular FX carry trades are being unwound amid the pickup in financial market volatility triggered by Operation “Epic Fury.” Low FX volatility earlier this year had encouraged a further build‑up of carry exposures. The unwind has been most evident so far in EM FX, where the HUF has fallen sharply by ‑4.6% against the USD, CLP by ‑3.6%, ZAR by ‑3.4%, PLN by ‑3.2%, and BRL by ‑2.8%. A broader reversal of carry trades could also be offering support for the JPY, as short funding positions are reduced. The JPY has held up better than other major currencies against the USD so far this week. This stands in contrast to the JPY’s performance in 2022, when it was one of the worst‑performing G10 currencies alongside the SEK, due to Japan’s negative terms‑of‑trade shock and the BoJ’s reluctance to raise interest rates. The current conflict in the Middle East could again make the BoJ cautious about hiking rates further at the start of this year.
USD strength is likely to prove temporary
However, we expect the USD rebound to prove short‑lived. Our latest forecasts (click here) are based on the assumption that Operation “Epic Fury” lasts weeks rather than months. If this proves correct, USD strength is likely to peak in the near term before reversing from Q2 onwards. We do not expect the Fed to respond with rate hikes as it did in 2022, leaving the foundations for a sustained USD rebound in 2026 far less robust. Provided energy prices begin to ease, we still see scope for the Fed to cut rates in the second half of the year. Furthermore, recent developments at the start of this year have highlighted that US policy uncertainty is set to remain elevated and a headwind for USD performance.
SQUEEZE UNDERWAY OF SHORT USD POSITIONS
Source: Bloomberg, Macrobond & MUFG GMR
TERMS OF TRADE SHOCK PULLED DOWN EUR/USD
Source: Bloomberg, Macrobond & MUFG GMR