Market Brief: Ceasefire holds—symbolically, at least—relieving global markets

Markets are steadying and crude prices are pulling back from their highs as the US and Iran avoid further escalation after a series of skirmishes in the Strait of Hormuz raised questions about the durability of the ceasefire struck in early April. Yesterday's American attempt to open the waterway—dubbed “Project Freedom”—sank at least six Iranian fast-attack boats and triggered drone strikes on cargo and tanker ships, along with missile attacks on infrastructure in the United Arab Emirates, sending energy benchmarks soaring. With Washington and Tehran making somewhat-conciliatory noises, Brent crude for July delivery is edging lower after jumping nearly 6%, Treasury yields are drifting down, equity futures are pointing to a modest advance at the open, and currency markets—with a few notable exceptions—are trading little changed from Friday's close.

The yen remains exceptionally volatile as traders weigh short-term intervention risks against more fundamental terms-of-trade exposures arising from Japan's dependence on imported energy. Last week’s buying effort by the Bank of Japan has resulted in a fairly-definitive “line in the sand” being drawn around the 160 threshold against the dollar, but the country’s reliance on oil shipped from the Middle East represents a major downside risk, and is likely to limit appreciation pressure for now. The dollar exchange rate has gapped* at least four times in the past day, underscoring how jumpy markets have become, and reinforcing demand for protection among hedgers.

The Australian dollar is trading with a softer bias after the Reserve Bank delivered what amounted to a “dovish hike”, raising rates while signalling a prolonged pause. Policymakers lifted the cash rate to 4.35% from 4.10%, effectively undoing last year's easing campaign, noting that the Middle East conflict had resulted in sharply higher fuel and commodity prices that were already feeding into inflation. Governor Michele Bullock struck a more cautious note, calling the war “a shock that makes us poorer,” worsening the trade-off facing policymakers at any given inflation rate, and saying “We feel we're now in a position where we've got space to be alert now to both sides of the risks to inflation—upside and downside”. Traders expect just one more increase this year, down from nearly two before the announcement.

The Canadian dollar is struggling to make headway even as crude prices march steadily higher, defying the currency's long-standing reputation as an oil proxy. Correlations between energy benchmarks and the loonie have flirted with negative territory throughout the Middle East conflict, reflecting persistent trade policy uncertainty from US tariff threats, deep structural vulnerabilities in the household sector, weak productivity, and the US dollar's reawakened positive gearing to oil prices. Trading ranges have also narrowed as US-Canadian rate spreads have converged, with expectations for both the Fed and the Bank of Canada nearing neutral, and removing the impetus for sharp exchange rate moves. We think the loonie will firm once the Iran conflict is resolved, but still-fragile fundamentals are likely to cap the currency’s gains later this year.

Long-term gilt yields are closing on multi-decade highs as inflation pressures intensify and political uncertainty rises ahead of what could be devastating local elections on Thursday, with some forecasts suggesting Labour could lose up to 90% of the council seats it is defending. The 30-year gilt hit a 28-year peak this morning as oil prices climbed, with investors betting the Bank of England will be forced to tighten further, while worrying that a potential successor to Keir Starmer might tack left, loosening fiscal rules and increasing government borrowing. Currency markets appear largely unmoved, however: implied volatility remains restrained ahead of the vote, and spot rates are holding firm against the dollar and euro. We think favourable rate differentials are playing a supportive role, but also suspect the elections won’t deliver the sort of crisp outcome that momentum traders often seize on to push currencies outside their ranges. Directional position-taking on the pound remains a difficult proposition.

Today’s agenda is crowded with second-tier US data releases that typically leave markets unmoved—but with traders questioning the economy’s momentum heading into Friday’s non-farm payrolls report, abnormally-large reactions are possible. Two in particular—the Job Openings and Labor Turnover Survey for March, and the Institute for Supply Management’s services survey for April—could have implications for interest rates by shedding light on labour market conditions ahead of Friday’s non-farm payrolls report and providing insight into how inflation dynamics are evolving in the largest sector in the US economy.

*A "gap" in currency markets refers to a sudden, sharp move where there is no trading activity at intermediate levels—the exchange rate essentially "jumps" from one level to another, skipping levels in between. This typically occurs when liquidity is very low and there aren't enough buyers or sellers to ensure two-sided price action, or when markets are hit with an unexpected shock that has very clear-cut trade implications. Needless to say, currency traders are not big fans of this sort of dynamic.

Market Overview

Notes: DXY: Dollar index, ON: Overnight movement, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

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