Stocks and bonds have fallen in tandem, an unusual and perhaps ominous development. In currency markets, the US dollar has retained its status as the ultimate safe-haven during times of geopolitical turmoil. More generally, US assets are outperforming the rest of the world's assets, reversing the Sell America trade that emerged after last year's tariff shocks. The Canadian dollar has emerged as another clear winner in this turmoil, benefiting from Canada's geographical isolation and its status as an energy exporter. The Norwegian krone (also an oil exporter) and the Swiss franc (a safe haven) joined them at the top of the currency performance table last week.
This week's economic and policy calendar is light, so developments in the Iran war should be far more critical for markets. A longer war, higher energy prices (oil futures have already jumped above $100 a barrel) and disrupted supplies will hurt energy-importing economic areas the most, particularly China and the Eurozone. Conversely, energy producers far from the conflict like Canada, Norway and Latin America, would benefit. These are exactly the moves we have seen in currency markets so far.
GBP
The UK is not quite as dependent on energy imports as the Eurozone. Markets have subsequently rewarded the pound with a nice bout of outperformance relative to the euro, although it hasn’t been able to keep pace with the dollar. Britain is, however, still a clear net importer of oil, which means that it is far more exposed to imported oil inflation than the US. These inflation fears have triggered a sharp sell-off in gilt markets and a savage repricing in Bank of England rate expectations, with swap markets pivoting from effectively fully pricing in two cuts in 2026, to now seeing a non-negligible possibility of a hike.
At the very least, we think that additional MPC interest rate cuts are completely off the table for now. Unlike in the Euro Area, inflation in Britain is already comfortably above target, and the liberalisation of UK markets, the push away from domestic oil production and a limited storage capacity ensure a rapid pass-through from higher oil prices to household energy bills. Combine these risks with Prime Minister Starmer’s hesitant and indecisive handling of the Iran conflict, and it may be tough for the pound to sustain its gains versus the euro.
EUR
The reversal of the 'Sell America' trade, driven by an influx of safe-haven flows into the greenback, has not been kind to the euro, which has fallen to near the bottom of its trading range of the last few months. Even before the impact of the energy shock arrives, February inflation surprised significantly to the upside. Our view that the next ECB move will be a hike has been vindicated, and swap markets are now almost fully pricing in two full interest rate increases by the Governing Council between now and year-end in response to these inflationary developments.
We will pay close attention to business surveys to gauge the impact of the Iran war shock, as a stagflationary environment once again looks like a real possibility for the Eurozone. Of course, the extent of the damage will be highly contingent on the length of the ensuing conflict, particularly the duration of the disruption to vessels passing through the Strait of Hormuz. At current levels in EUR/USD, we think that markets are already pricing in a war that lasts weeks, not days, but there remains room for further downside in the pair should we see further escalation and a prolonged bout of oil supply disruption.
USD
As is customary during times of market stress, the dollar has been seen as the ultimate safe-haven due to its liquidity, while also being buoyed by the rise in oil prices due to America’s standing as a net energy exporter. Last week’s February payrolls report was quite weak, a mirror image of the strong January one. There was net job destruction and an uptick in the unemployment rate, with both data points reversing January gains. We note that this weakness seems to contradict strong data elsewhere, making us increasingly skeptical of the quality of the surveys on which it is based. Markets mostly ignored the data, however, with investors fully focused on the Iran war.
In light of the low passthrough of oil prices to inflation, we’ve seen a much less aggressive repricing in US interest rate expectations than across the Atlantic in response to the jump in oil. Futures markets continue to more than fully price in another rate cut from the Fed before the end of 2026, with a near coin-toss of one in June. This week's February inflation report will not yet reflect the recent sharp increases in energy prices, but it nevertheless will be important as attention shifts from growth to renewed upward price pressures caused by the war.
