US-Iran Talks Sour Sentiment

MACRO FRAME

Inflationary fears are back in focus after Islamabad peace talks collapse after 21 hours and President Trump announces US naval blockade of all Iranian ports. March CPI revealed the energy shock, though the core reading provides a reassuring signal that broader inflationary pressures have not dramatically increased.

STOCK INDEX FUTURES

Risk sentiment has soured materially following the collapse of US-Iran ceasefire negotiations in Islamabad and President Trump’s subsequent order to blockade the Strait of Hormuz. Equity index futures are broadly lower, oil prices have surged 7%–8%, and safe-haven demand has lifted the US dollar. While March’s core CPI reading of 2.6% YoY confirms that energy-driven inflation has not yet penetrated underlying price pressures, the escalatory trajectory of the conflict creates persistent headwinds for equities. Markets are unlikely to find durable footing until a material breakthrough in hostilities materializes.

VP Vance and envoys Witkoff and Kushner concluded the marathon session in Pakistan with no deal. Vance said Iran “chose not to accept our conditions,” while Iran’s Vice President Mohajerani countered that “the worse news is for the United States.” Iran refused to halt uranium enrichment, dismantle nuclear facilities, or end support for proxies — all core US demands. Iran’s Fars News Agency reported Tehran has “no plan for a next round of negotiations.”

Hours after the talks failed, Trump declared the US Navy would begin the process of blockading any and all Ships trying to enter, or leave, the Strait of Hormuz. However, CENTCOM clarified that the blockade targets vessels entering or departing Iranian ports and coastal areas, but will still allow ships transiting between non-Iranian ports through the Strait. Oil prices have risen 7%-8% in response, reigniting fears that the sustained rise in energy prices could make its way into the broader economy. However, March’s core CPI reading showed no energy-driven rise, signaling that underlying inflation remains contained.

Watch point: The “no next round” language removes the sentiment that propped up last week’s rally is gone, leaving markets open to headline trading and heightened volatility.

CURRENCY FUTURES

US DOLLAR: The USD index is 0.32% higher at 98.97 as demand for dollar liquidity rises following the failure of peace talks between the US and Iran over the weekend.  Developments in the Middle East continue to have an outsized impact on price direction in currency markets. The conflict has evidenced that the dollar remains a preferred safe haven asset for investors, a theme that is likely to continue as hostilities between the two warring countries continues.

While safe haven demand is likely to prop up the dollar in the face of the conflict, underlying fundamentals make the case for a resumption of the dollar’s downward trend once hostilities in the Middle East are officially over. Despite rising inflationary pressures driven by energy prices, the dollar has lost its interest rate differential support it once drew from hawkish Fed expectations, support that has since been repriced away. With the labor market softening materially, the underlying case for a Fed rate cut later in the year remains intact.

Watch point: Despite March’s hot inflation print and a sticky February PCE reading, a move up from the Fed is out of the picture as the Fed is well positioned in its policy rate for the time being, though a weak labor market leaves the door open for easing.

EURO: The euro is down 0.30% to $1.1685 as risk sentiment comes off the table following the failure to reach an agreement to end the war in Iran. Developments regarding the ceasefire between the US and Iran remain the dominant factor in price direction for the euro. The failure of a comprehensive agreement between the two sides has dramatically shifted expectations for near-term tightening since Friday. Markets are now pricing a 51% chance of an April rate hike, a steep move up from Friday’s 32%. The risk of a prolonged rise in energy prices makes a more appeal case for a hike at the June meeting. The path to tightening from the ECB will hinge on the effectiveness of the two-week ceasefire and whether it brings lasting peace. The critical risk factor is the persistence of the energy shock.

Watch point: March’s inflation data confirmed that headline inflation was dragged higher by rising energy prices, while other components were reassuring to the broader inflationary picture. A rate hike at the ECB’s April meeting is unlikely, while the case for tightening depends on the effectiveness of the ceasefire and duration of the rise in energy prices.

BRITISH POUND: Sterling is 0.30% lower to $1.3425. Price direction in FX markets continues to be dominated by developments from the US-Iran conflict. The Sterling continues to come under pressure when tensions between Washington and Tehran flare, given Britain’s dependence on energy imports and the economy’s sensitivity to higher energy costs. As a result, market expectations for Bank of England tightening have risen since market close on Friday; markets are now pricing 50 bps of tightening by year-end, up from 39 bps on Friday.

However, the weakness of the UK economy remains a limiting factor for potential tightening and market-implied odds appear to be overshooting realistic BoE policy. BoE Governor Andrew Bailey said earlier this month markets were getting ahead of themselves by betting on rate rises. Money markets had previously been pricing in two rate cuts this year before the outbreak in hostilities as economic growth remains stagnant, business activity growth is slow, while falling wage growth and a weak employment picture in the country remain favorable for policy easing by year-end rather than tightening. However, the case for policy easing out of the BoE remains subject to the effectiveness of the ceasefire and if oil prices can drop closer to pre-war levels, given that inflation in the UK remains among the highest in the G7. If those dynamics fail to materialize, the case for policy easing may be out of the picture.

Watch point: The escalation between the US and Iran continues to drag on the GBP, while pre-war macroeconomic factors present a hurdle for BoE policy tightening.

JAPANESE YEN: The yen is 0.30% weaker against the dollar at 159.82 yen per dollar as JGB yields continue to push multi-decade highs, with the 10-year up 5.5 bps to 2.49% and the 5-year touching a record 1.87%, as domestic bond markets reprice for a prolonged inflationary environment tied to the Iran conflict. Bank of Japan Governor Kazuo Ueda said on Monday that economic and price developments were moving roughly in line with the bank’s forecasts, but called for vigilance over the impact of the conflict in the Middle East.

Swap markets now assign a 26% probability of a BoJ rate hike in April. While rising yields are nominally supportive of JPY via narrowing rate differentials, the yen’s near-term trajectory remains hostage to geopolitical developments, a durable ceasefire could quickly unwind oil-driven inflation expectations and reduce urgency for BoJ action, though the bank is set to maintain its tightening bias. The risk of policy errors is relatively higher in Japan and Europe, meaning that flows could return to USD assets for lack of better alternatives

Watch point: An April rate hike could pull USD/JPY closer to 155, though the odds of such happening appear unlikely at the time being.

AUSTRALIAN DOLLAR: The Aussie is 0.33% lower at $0.7038. Developments in the Middle East continue to be the driver of price action for the risk-linked currency, though rising inflationary pressures and expectations of tightening from the Reserve Bank of Australia offer underlying support for the currency. Markets imply a 67% chance of another quarter-point rise in May, and see rates at 4.70% by year-end. While a durable ceasefire would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to keep the RBA on a tightening path.

Bonds took a kicking on inflation fears. Three-year Australian government bond yields rose 5 bps to 4.713%, while the 10-year yield jumped 6 bps to 5.208%. Reserve Bank of Australia Deputy Governor Andrew Hauser will speak in New York later on Monday. Australia will publish its monthly jobs data for March on Thursday where any labor market disruptions from the ongoing Middle East conflict will be closely monitored.

Watch point: The RBA is likely to maintain its tightening bias amid persistent inflationary pressures. However, weaker growth prospects raise risks to gains in the currency.

TREASURY FUTURES

Yields are little changed across the curve, with prices little changed in response to this morning’s data, which if not for the sticky inflationary print, would otherwise be friendly to prices.

The spread between one- and two-year inflation swaps has widened to 32.3, reflecting sentiment that the impact of higher energy prices will be transitory, much like the impact of tariffs on prices. Swaps have fallen substantially in response to the ceasefire despite the fact that tanker traffic through the Strait is still lackluster. As of April 8, AIS data confirmed no surge in transits despite the ceasefire announcement, as shipowners await clarity on security arrangements, insurance cover, and potential Iranian transit fees that could implicate US sanctions. Beyond the physical market, financial measures of longer-run inflation show little alarm. The latest New York Fed survey revealed that consumer expectations for inflation three years from now edged up only a modest 0.1% last month, while the five-year/five-year breakeven rate remains below 2.2%, broadly consistent with the Fed’s longer-run PCE target. With 2-year swaps holding near 2.5–2.75% and longer-run inflation expectations remaining well-anchored, the Fed has room to treat any near-term CPI acceleration as transitory without adjusting its current policy and leaving the path for rate cuts later in the year open.

Watch point: Following March’s labor data, an immediate case for a change in Fed policy remains unlikely. March’s CPI data is expected to show a rise in prices, though evidence of sustained inflation will be closely monitored for impacts on policy expectations.

The spread between the two- and 10-year yields is 50.80 bps, while the two-year yield, which reflects short-term interest rate expectations, is 3.73%.

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