According to the president, “very good and productive” talks were had between US and Iranian officials, with military strikes postponed for a five day period. Brent crude oil futures have sunk back towards $100 a barrel, European stocks are up, bond yields are dropping sharply and the US dollar has given back some of its gains. Whether this heralds the start of another TACO trade is unclear, particularly as Iran appears to be denying the story, and risk sentiment could take a fresh hit should the path to a ceasefire run into any snags.
All eyes will remain on the war headlines, particularly the prospect of the Strait of Hormuz reopening. Investors are starting to look at the secondary effects of the sharp rise in energy prices, and are particularly worried about the need for central bank tightening to offset inflationary pressures, which is starting to drive relative currency moves. The Bank of England, ECB and Federal Reserve all sounded a hawkish note last week. The impact on rate projections has been particularly marked in Europe, with at least three rate hikes priced in for both the Bank of England and the ECB in 2026. Tuesday’s PMI figures will be closely watched, as they will be the first data point to fully reflect the war’s impact.
GBP
The Bank of England left rates unchanged as expected with a 9-0 unanimous decision, as even the ultra-doves on the committee sought it wise to refrain from voting for an immediate cut. The inflation forecasts were revised up and by saying that policy may need to be more restrictive in response to the war, the MPC explicitly warned markets that it may need to raise rates in the not too distant future. However, it did stop short of validating the numerous hikes that have been priced into 2026 by markets, no doubt conscious of the extreme uncertainty over the duration of the war and the price of energy.
The selloff in government bonds has been most extreme in the gilt markets, as both the 10-year and the 30-year yields broke to near two-decade highs. Our early view is that the rate repricing we’ve seen has been overly aggressive, as not only are supply shocks self-limiting, but this seems to be assuming an absolute worst-case scenario for the war, which is far from guaranteed to come to pass. This week's inflation report for February (Wednesday) would ordinarily command all the attention, but the Iran war has rendered it stale. Therefore, the focus will be on Tuesday's PMI business activity surveys.
EUR
The ECB also held rates unchanged last week in a unanimous decision. While President Lagarde did not validate market expectations for cuts, she did not push back against them, while the infamous “ECB sources” signalled a potential hike at the bank’s April meeting, which is now roughly 80% priced in by swap markets. These expectations continue to close the rate gap between the US and the Eurozone, which is perhaps contributing to the euro's relative stability as other currencies are sold off.
In addition to the initial read of business sentiment in the PMIs and other investor surveys this week, we look forward to Lagarde's speech at the ECB Watcher's conference on Wednesday. The key for central bankers in the coming weeks will be how they perceive the war impacting second-round inflationary effects, namely whether supply-chain disruptions translate into sustained wage pressures that entrench inflation expectations above target. Our stance is that slack in labour markets limits these risks, but policymakers may well hold a different view.
USD
The Federal Reserve also refrained from changing rates last week. However, alone among the major central banks it registered a dissent, as Trump's appointee Miran again voted for a cut. Chair Powell was unsurprisingly non-committal during his press conference, effectively batting away every opportunity to provide clarity to markets on how the geopolitical situation could impact the US economy and Fed rates. The Fed’s updated macroeconomic and interest rate projections offered a bit more colour, as the PCE inflation forecasts were upped, while the average ‘dot’ for 2026 continued to show one cut this year.
The energy price spike comes at a time when most inflation measures like producer prices and PCE inflation were already showing signs of a rebound. Let's not forget that this is the sixth consecutive year the Fed has failed to achieve its inflation target. The Treasury market is certainly voting with its feet, and even long-term bonds are selling off as the central bank's credibility comes into question.
Deep dives and expert insights:
- G10 currency market report - Get the latest analysis on major currencies.
- Iran War FX Scenarios
- Iran War: Winners and Losers in FX
