Middle East Conflict Prolongation May Undermine Safe-Haven Properties of US Dollar Assets

The spillover effects of the Israel-U.S. conflict are becoming increasingly evident. Geopolitical risks have become a key variable influencing global asset pricing and may accelerate the rebalancing of global asset allocation. During this process, the outlook for U.S. assets has become more uncertain, and their traditional safe-haven attributes are increasingly questioned.

Market analysts believe that if the Middle East conflict persists, combined with factors such as significant U.S. exposure to risk in the war zone, rising international energy prices disrupting the Federal Reserve’s policy adjustments, and structural risks in the U.S. financial markets, the safe-haven status of U.S. assets could be undermined.

U.S. assets have long been regarded by investors as hard currency, offering strong liquidity and risk mitigation functions. During times of turmoil in the geopolitical and financial systems, U.S. assets tend to be highly sought after. Since the outbreak of this conflict, the dollar index has strengthened somewhat, but the overall gain has been modest, and not all dollar assets have benefited equally from safe-haven premiums. There has been no sign of large capital inflows into U.S. assets.

Reuters recently cited data from a research firm specializing in emerging market securities funds, reporting that in the week ending the 11th, global emerging market bond funds experienced net outflows of about $1.1 billion. The dollar index against six major currencies also did not rise steadily; on the 17th, it fell 0.13%, closing at 99.574.

Notably, yields on the 10-year and 2-year U.S. Treasury bonds have recently risen, which is inconsistent with the traditional safe-haven logic of declining yields during initial phases of geopolitical conflict. This has led some market participants to question the safe-haven nature of U.S. assets, with some describing it as a “failure of safe-haven” for dollar assets.

U.S. companies have hundreds of billions of dollars in direct investments in the Middle East, covering critical sectors such as energy and digital infrastructure. According to reports from Reuters and other media, recent drone attacks by Iran damaged two data centers operated by Amazon in the UAE, causing power outages and affecting cloud services. This incident has raised concerns that U.S. and Western tech companies’ overseas digital infrastructure could become targets for military strikes.

In response, Pan Xiangdong, Chief Economist at Beijing-based Qilai Research Institute, told reporters that if U.S. and Western digital infrastructure continues to be targeted militarily, the risk premiums for U.S. assets in the Middle East will become normalized, leading to increased operational costs, lower return expectations, and impacts on asset safety and profitability. Technology assets are expected to be the first to face valuation pressures, further weakening their attractiveness.

Another market focus is whether the conflict will influence the Federal Reserve’s policy adjustments. Initially, under U.S. government influence, the Fed had been signaling rate cuts to stimulate economic growth before the conflict erupted. However, if the conflict causes international energy prices to enter a prolonged upward cycle, the resulting inflationary pressures could force the Fed to pause or delay rate cuts.

Patrick Minford, Professor of Applied Economics at Cardiff University Business School, believes that current market confidence in U.S. assets is affected by domestic policy uncertainties. The U.S. government’s persistent fiscal deficits have shaken long-term confidence in U.S. Treasury bonds, and rising bond yields partly reflect investor concerns about future inflation and policy uncertainty.

Meanwhile, structural risks in the U.S. financial markets have also raised alarm. The Financial Times recently reported that redemption requests in the first quarter for the flagship fund of Cleveland-based firm Clifwatt surged to 14% of its size, far exceeding the 5% quarterly redemption limit set by U.S. regulators. Major Wall Street firms like BlackRock, Blackstone, Morgan Stanley, and private credit firms such as Blue Owl have also experienced mass redemptions, triggering redemption restrictions. Market analysts worry that the U.S. private credit industry, worth trillions of dollars, may be facing a liquidity crisis, with potential chain reactions that should not be underestimated.

Australian economist Guo Shengxiang pointed out that if the Middle East conflict cannot be resolved in the short term, investors will likely withdraw even more from high-risk assets like private credit. In such cases, institutions may be forced to sell assets at distressed prices, exacerbating market downturns. Without proper regulatory and bailout measures, the U.S. private credit sector could face a systemic crisis triggered by a run on funds.

Shisham Farag, Professor of Finance at Birmingham University, UK, believes that in recent years, countries have become more aware of the political risks within the dollar system and are exploring ways to reduce dependence on the dollar, such as expanding local currency settlements or using alternative reserve assets. While the dollar remains the main safe-haven asset globally, factors like U.S. trade policies could weaken it again, gradually changing the structure of global capital allocation.

Pan Xiangdong also suggests that prolonged conflicts could undermine the foundation of the petrodollar system. Coupled with the global push toward de-dollarization, this would weaken the dollar’s credibility and prompt long-term global capital to reassess asset allocation strategies, gradually reducing exposure to dollar assets. Its long-term valuation and attractiveness are expected to decline accordingly.

Cang Shishan, CEO of Middle East Shanshuo Jinke Group, stated that for investors, geopolitical conflicts often cause short-term market sentiment swings and asset price adjustments. However, over the longer term, the key factors determining international capital flows remain institutional stability, financial system maturity, and openness. While wars may alter regional power dynamics, the fundamental logic of capital seeking stable financial hubs and efficient financial nodes remains unchanged.

(Article source: Economic Information Daily)