Market Brief: Iran relief rally punishes dollar

A tentative relief rally is unfolding across global markets after the US and Iran agreed to a two-week ceasefire, with yields falling, equities climbing, and the dollar tumbling against its major rivals in early action. US president Donald Trump yesterday threatened to hit civilian targets across Iran, wiping out a “whole civilization,” but reversed direction before his self-imposed deadline, claiming that Pakistan had brokered a compromise and saying “Almost all of the various points of past contention have been agreed to between the United States and Iran, but a two week period will allow the Agreement to be finalized and consummated”. Both global crude benchmarks are off more than 16 percent relative to yesterday’s highs, Treasury yields are sharply lower, and the euro, British pound, Swiss franc, and Japanese yen are all up more than a full percentage point against the greenback.

Tail risks have been reduced, but price action could lose momentum in the coming hours. Military action continued around the Gulf overnight, with Israel striking targets in Iran and Lebanon, Iranian units firing missiles at neighbouring countries, and the US moving more hardware into the region. Reports this morning have cast doubt on key aspects of the supposed ceasefire: Iran appears committed to charging a toll on shipping through the Strait, and is threatening to destroy vessels that attempt to navigate it without permission. Tehran has also circulated a ten-point plan that appears far removed from what Trump yesterday called a "workable basis for negotiations,” and Washington is outlining plans for the removal of Iranian nuclear materials that don’t align with statements from the other side. Israel and Pakistan, meanwhile, are debating whether Tel Aviv's actions against Iranian proxies fall within the agreement's scope. Traders are unlikely to take major directional positions while these uncertainties persist.

Energy prices could remain elevated for many months yet, even if the ceasefire holds. Restarting an interconnected production, refining, and logistics ecosystem degraded by physical damage, forced shutdowns, and weeks of supply-chain dislocation will be a protracted process. Clearing an on-water backlog amounting to almost 172 million barrels of crude and petroleum products could take weeks, and insurance and transport costs will stay elevated long after the crisis ends. Shut-in wells require careful pressure management to avoid reservoir damage, refineries must undergo lengthy restart sequences, and liquefied natural gas facilities need gradual re-cooling before returning to normal operations. Underlying demand will remain strong as end-users recalibrate refining processes and countries begin replenishing reserves, and the geopolitical risk premium built into paper markets won’t disappear as long as Iran retains the power to close the Strait and damage regional infrastructure*.

Economists expect the first clear evidence of the war's impact on the US economy to surface on Friday, when the Bureau of Labor Statistics is likely to report a substantial jump in headline inflation. Forecasters think consumer prices surged by around 0.9 percent in March, lifting annual inflation to 3.3 percent from 2.4 percent previously, even as core measures—which remove food and energy inputs—remain tame.

At the risk of angering the market gods by using a very bad word, we think this will prove transitory, with limited implications for monetary policy. Upward pressure on prices is likely to remain for several months at the least, but a record of the Federal Reserve’s mid-March meeting—due for release later today—is likely to show officials remaining willing to follow long-standing practice in “looking through” commodity-led price changes in the short term. Measures of inflation expectations remain well-anchored, and signs of slowing demand elsewhere in the US economy should keep the Fed firmly on an easing trajectory, even if it is more gradual than investors had hoped earlier in the year.

The Canadian dollar is climbing on an improvement in risk appetite and borrowing costs, reflecting the fact that its long-standing role as a petrocurrency has eroded markedly in recent years, with 30-day crude oil correlations falling to near zero. The breakdown reflects a structural transition in the Canadian economy as the debt and housing bubbles deflate, trade uncertainties weigh, and prospects for renewed capital expenditure in the energy sector remain dim. It also reflects a changed relationship between the US dollar and crude: the shale revolution turned the United States into the world's largest oil and natural gas producer, meaning energy price swings now feed more directly into American trade balances, capital flows, and Fed policy expectations.

Bottom line: Government bond and currency markets are now reversing some of the overshooting that occurred in recent weeks, but sentiment remains fragile and second-order effects have yet to arrive. Levels are unlikely to fully revert to pre-war norms, and reversals should be expected in the near term. Hedgers should look for tactical opportunities to play wider ranges.

*It’s worth noting that Iran doesn’t need to levy tolls on shipping through the Strait of Hormuz to maintain its negotiating leverage. After a series of unforced errors by the US, Tehran has shown it can bring global oil and gas markets to their knees, and it looks likely to retain that power for the foreseeable future.

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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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