Wars rarely stay where they start. The Israeli and American military campaign against Iran—the most direct confrontation with Tehran in decades—has sent shockwaves well beyond the Middle East. The fog of war obscures the tactical picture almost daily, but the economic transmission mechanisms are clear enough, and investors who mistake this for a regional skirmish over energy do so at their peril.
One-Two Punch
The first punch is inflationary. Iran is not a bit player in global commodity markets. It sits atop some of the world's most consequential supply chains—not just oil and gas, which command the headlines, but sulfur and urea, which quietly underpin the global food system. Sulfur is a critical feedstock for phosphate fertilizers. Disrupt that supply, and you are not merely raising the price of a barrel of crude; you are raising the price of wheat in Egypt, corn in Brazil, and bread in Lagos.
Energy markets feel the shock first and most visibly, but the agricultural commodity complex is where the second-order damage accumulates, slowly and with devastating effect on the world's most food-insecure populations. Industrial commodities, like aluminum and helium (essential for semiconductor fabrication), have also been disrupted.
The second punch destroys demand. That is the cruel arithmetic of commodity shocks. The same price surge that generates windfall revenues for producers squeezes household budgets everywhere else, sapping the consumer spending that drives global growth. It boosts input costs for many manufacturers, and corporate margins compress. Capital expenditure plans go on hold.
The very inflation that appears to signal economic heat is, in this context, a leading indicator of demand destruction. Central banks find themselves in the most uncomfortable of positions: facing prices that argue for tightening while growth signals argue for caution. It is stagflation's calling card, and it arrived before most were ready to receive it.
Monetary Policy Adjustments
While market participants seem to be inclined to expect a relatively short war on Iran, the pendulum of interest rate expectations swung dramatically. There was a clear bias towards expecting the easing cycle to continue before the war began. The market was sure of Bank of England and Federal Reserve rate cuts; it was less confident but retained a bias toward the European Central Bank and the Bank of Canada cutting rates themselves.
The swaps market was more extreme but even now it is discounting around a 65% chance of a hike at the ECB's next meeting at the end of April. Three rate hikes are fully discounted for this year and about 20% chance of a fourth.
The swaps market has a little less than 60% chance of a Bank of England hike when they too meet on April 30. Three hikes are fully discounted for this year and a little bit more. On the eve of the war, the market had two cuts fully discounted, and a small chance of a third.
Before the war, the futures market was pricing in two rate cuts by the Federal Reserve and a 40% chance of a third. It is now discounting slightly more than 60% chance of a hike by the end of the year.
From Trade Wars to Kinetic Wars
There is a larger context that deserves to be attention. The United States has now bombed at least seven countries since the start of last year. Whatever one's view of the strategic rationale in any individual case, the cumulative picture is of a rules-based international order in accelerating dissolution.
The institutions and norms that once provided a framework for managing conflict—however imperfectly—are being bypassed with increasing frequency and diminishing apology. This is not a temporary disruption. It is a structural shift in the geopolitical environment in which all economic activity takes place. Risk premiums that were compressed during decades of relative stability need to be repriced, and that repricing is neither linear nor orderly.
The truth is said to be the first casualty in a war, but it was already challenged before the first strike. Battle damage assessments are contested. Escalation ladders are unpredictable. A drone strike, a tanker seizure, a miscalculation in the Strait of Hormuz—any of these can move markets in minutes with information that takes days to verify. Volatility is not a momentary condition to be waited out; it is the operating environment, and it demands to be managed accordingly.
Trusted Advisers
Which brings us to the only actionable conclusion available in moments like this: discipline matters more, not less, when the news is loudest. Diversification, position sizing, stop-loss discipline, and a clear-eyed assessment of tail risks are not optional refinements for calm markets—they are the minimum requirements for navigating turbulent ones.
The instinct to act decisively on incomplete information is precisely what fog-of-war conditions seem to tempt. The antidote is a disciplined process, a reliable framework, and trusted advisers who have seen cycles before. In markets shaped by forces this large and this fast-moving, the quality of your decision-making process is the only edge you can reliably control.
Bannockburn World Currency Index
Bannockburn's World Currency Index, a GDP-weighted basket of the currencies of the dozen largest economies, snapped a four-month advance and posted its biggest decline (about 1.25%), since last July. The decline reflected the fact that all of the components of the index fell against the dollar. In fact, the decline brought BWCI back toward the lows for the year recorded before recovering near mid-January.
Among the G10 currencies, sterling fared the best, losing "only" about 1.6%. It may have been supported by the rate expectations adjusted in the UK, which was the most extreme. Before the war began, the market's disappointment with the UK economic data saw the two-year yield approach 3.5%, the lowest since August 2024. At its peak on March 23, it briefly traded above 4.70%. The Canadian dollar fell by about 1.8%, making it the second-best performer among the G10 components.
The Australian dollar was the worst G10 component in the index. It fell by about 3.5% in March, giving back around half of what it had gained in the first two months of the year, which had put it atop the G10. The Australian dollar was helped by the two rate hikes and hawkish tone the central bank delivered. The euro and yen declined by about 2.5-2.6%.
Among the emerging market currencies in Bannockburn's World Currency Index, the Chinese yuan's 0.70% decline was the best performer. The relative stability of the yuan and Chinese interest rates may be encouraging another look by global asset managers. The Brazilian real was in second place with a little more than a 2.2% decline. The others lost more than 4%, with the Russian ruble off around 5.5%. Although the US relaxed a restriction on Russian oil, and Moscow is charging a premium for it over Brent (before the war it was at a discount), the war with Ukraine as intensified. Ukraine reportedly struck an important refinery (Kirishi) in Leningrad as well as other Russian oil processing and industrial facilities in the Baltic region.
Bannockburn's World Currency Index reached its best level since September 2024, around 92.25 in mid-February before falling in March. Escalation of the conflict could push the index another 0.75%-1.0% lower that would bring it to around last April's lows. A ceasefire could see the BWCI back to the mid-February high, A new high would lend credence to our medium and longer-term bearish outlook for the dollar.
U.S. Dollar: The dollar was recovering from the sell-off the incurred when the US was pressing hard on Greenland, but the war on Iran gave it new impetus. Part of it seemed driven by position adjusting, like the unwinding of carry-trades and foreign investors buying back short dollar hedges on equity investments. The US is seen as more able to deal with the energy shock than Europe and this may have encouraged some genuine safe haven demand for dollars. Although there has been a dramatic adjustment in expectations for the Federal Reserve, it has generally been less than in many other countries. Yet, first instance, the surge in US rates is supportive of the dollar, even though interest rate differentials have moved against it. Each time the market grasped the faintest of hopes of a short-term war, the dollar is sold off as risk is embraced. The swaps market is discounting a much higher chance that the European Central Bank, the Bank of England, and the Bank of Japan lift rates in April than the Federal Reserve. The investigation into the Federal Reserve has not formally ended and this is holding up the confirmation process of Powell's successor, Warsh. There is precedent for Powell, who is also a governor (until 2028) to retain the post until a successor is confirmed. Meanwhile, it is possible that the complaint against the administration's 10% tariff under Section 122 of the 52-year-old trade act is heard by the US Court of International Trade. Regardless of the outcome, eventual decision will be appealed. The 150-day limit on Section 122 legislation, without a congressional-authorized extension, ends on July 24.
Euro: In addition to fraying the alliance some more, the US-Israel war on Iran posed a new energy shock for Europe, and the euro was sold to seven-month lows in the middle of March near $1.1400. Brent crude oil rose to a decade-high premium over the US benchmark, WTI. The euro was a little above $1.18 before the war began. The ECB stood pat in March, but the hawks insist that a hike cannot be ruled out as soon as the next meeting at the end of April. The swaps market has about 60% chance discounted for that meeting. Before the war began, the market had around a 55% chance of a cut this year and now has three hikes fully discounted and about a 10% chance of a fourth hike. This seems excessive. The ECB's updated forecasts recognize the two-way risk. The new economic projects shaved growth this year to 0.9% (from 1.2%) and next year's growth to 1.3% (from 1.4%). The inflation outlook worsened. The updated forecast is for 2.6% CPI this year (from 1.9%) and 2.0% next year (from 1.8%). Part of the ECB's reaction function may depend on how the governments respond. ECB President Lagarde explicitly called for governments to limit energy assistance to temporary and targeted efforts.
(As of March 27, indicative closing prices, previous in parentheses)
Spot: $1.1509 ($1.1812) Median Bloomberg One-month forecast: $1.1607 ($1.1900) One-month forward: $1.1525 ($1.1832) One-month implied vol: 7.8% (5.9%)
Japanese Yen: The dollar rose to almost JPY160 last month, its highest level since July 2024. The war had a more muted effect on Japanese markets than it did in Europe or the United States. The 10-year yield rose a little more than 25 bp and the two-year yield rose by around 17 basis points. Before the war began, the swaps market was pricing in about 44 bp of tightening this year and is now discounting about 56 bp. The Bank of Japan next meeting concludes on April 28. Given the upward revision in Q4 25 GDP (1.3% at an annualized rate from 0.2%) and the strong start of this year (January industrial product rose by 4.3%, more than in 2025, and a 1.7% increase in tertiary activity, which was also more than last year), we suspect the odds of a BOJ rate hike in April are more than the 69% chance being discounted by the swaps market. The largest labor union federation secured a preliminary increase for average pay of 5.26%, topping 5% for the third consecutive year. The dollar reached JPY160.30 on March 27, the first breach of JPY160 since 2024, when it got to almost JPY162. Returning there seems a strong possibility. Bank of Japan and the Ministry of Finance officials seem more sophisticated than drawing a fixed intervention line at JPY160. It has been a broad dollar advance, and the greenback's rise against the yen has been orderly. The yen's 2.5% loss puts in near the middle of the performance of G10 currencies since the war began. It has not simply been a one-way market. One-month implied volatility is firm, mostly chopping between 9% and 10% this month, well off the January peak near 11.5%.
Spot: JPY160.31 (JPY156.05) Median Bloomberg One-month forecast: JPY158.52 (JPY154.00) One-month forward: JPY159.90 (JPY155.65). One-month implied vol: 9.9% (9.2%)
British Pound: The British economy was struggling before the war began, and the fiscal headroom was limited. The economy unexpectedly stagnated in January. Industrial production contracted and services output was flat. Before the war began, the swaps market was convinced that the Bank of England would cut rates at least twice this year with around an 80% chance of a cut in March. The spike in energy prices caused a violent shift in the market's outlook. The BOE stood pat at last month's meeting and some members of the Monetary Policy Committee seemed open to a rate hike. The next meeting is at the end of April, and swaps market has about 50% chance of a hike discounted and has almost 75% chance of at least two more hikes this year. The two-year yield jumped more than 100 bp last month. Despite a small pullback, it is still up around 95 bp. This seems to be excessive. And to be sure, sterling found little comfort from the surge in rates. After posting a February high near $1.3715, sterling overshot the $1.3250-$1.3300 target we suggested and found support near closer to $1.3220. To confirm a bottom is in place, sterling needs to re-establish a foothold above the $1.3465 area, while a break of $1.3180-$1.3200 could encourage a move toward $1.3000-50.
Spot: $1.3259 ($1.3482) Median Bloomberg One-month forecast: $1.3306 ($1.3600) One-month forward: $1.3260 ($1.3480) One-month implied vol: 8.4% (7.2%)
Canadian Dollar: In the generally firmer US dollar environment in March, the Canadian dollar was among the best performers in the G10. It lost about 1.65%, only bested by the British pound. We think that the conventional narrative often exaggerates the link to oil prices. In fact, the rolling 30-day correlation between changes WTI and the US dollar's movement against the Canadian dollar have swung from inverse to slightly positive since the middle of March, for the first time since early last November. Our alternative explanation is the Canadian dollar moves in the US orbit and in a rising greenback environment does relatively better, and the opposite is also true. We note that the volatility of the exchange rate is typically the lowest among the major currencies. The swaps market had been discounting about a 45% chance of a cut by the Bank of Canada before the war began but is now pricing in two hikes fully and about 50% chance of a third hike. While Bank of Canada Governor Macklem was adamant that the central bank would not allow prices to fuel persistent inflation, he recognized that unlike the energy shock in 2022, the economy is soft. In February, Canada lost the most jobs in four years. The Canadian economy has been rattled a drop in exports and business investments, spurred by the shift in US policy. The US is engaging in separate talks with Mexico and Canada over the USMCA, with Prime Minister Carney looking to diversify its trading partners. The US dollar has risen above the down trendline from drawn off the late November 2025, January 2026, and mid-March 2026 highs. The mid-January high, near CAD1.3930 may be the next target and then the CAD1.40 area beckons.
Spot: CAD1.3893 (CAD 1.3650) Median Bloomberg One-month forecast: CAD1.3795 (CAD1.3700) One-month forward: CAD1.3875 (CAD1.3630) One-month implied vol: 5.2% (4.9%)
Australian Dollar: A little more than two weeks into the war on Iran, the Reserve Bank of Australia delivered its second interest rate hike of year. A week before the hike, the Australian dollar reached almost $0.7190, its best level since mid-2022. It spent most of the month consolidating within the range seen on March 3 (about $0.6945-$0.7125) before sliding for five consecutive sessions and pushing through support near $0.6900. The break could signal another cent, or more, of losses, if there is no near-term resolution of the war in the Middle East. There has been a significant shift in market expectations for the trajectory of RBA policy for the remainder of the year. Before the war began, when the overnight cash target rate was at 3.85%, the futures market expected the rate to be around 4.20% at the end of the year. The cash target rate is now 4.10% and the pricing in the futures market sees it at 4.82% at the end of the year. As with expectations for many of the G10 central banks, this seems excessive. The central bank meets next in early May, and the futures market has almost 80% chance of a hike. We are less sanguine given the two hikes already delivered in succession. The Reserve Bank of New Zealand meets on April 8, and the risk of a rate hike seems minimal. The divergence of monetary policy has helped lift the Australian dollar to its best level against the New Zealand dollar since 2013, reflecting around a 4.75% move this year. A downside correction appears to have begun, which adds an additional drag on the Australian dollar.
Spot: $0.6874 ($0.7118) Median Bloomberg One-month forecast: $0.6950 ($0.7000) One-month forward: $0.6875 ($0.7120) One-month implied vol: 11.8% (9.3%).
Mexican Peso: The Mexican peso had its worst month since August 2024, when it fell almost 6%. It depreciated by about 4.5% in March. Its decline was driven by several considerations. Like other high yielding emerging market currencies, it had benefitted from carry trades. The dollar was used to fund purchases of Mexican bonds and when the bonds were liquidated the short dollar was covered. Another consideration was the broad risk-off activity, and this also weighed on the Mexican peso. The inverse 30-day correlation between changes in the S&P 500 and the dollar against the peso reached the most extreme since mid-2020 (-0.80 in mid-March). The central bank surprised many with a rate cut in late March to bring the policy rate to 6.75%, despite inflation pushing above the top end of the 2%-4% target. The central bank also signaled it may cut rates again. We expect that the end of hostilities will see the peso recovery quickly and remain more bullish the peso than the market, where the median in Bloomberg's survey sees the dollar around MXN17.88 at the end of the year. That said, we recognize that the USMCA talks are a wild card even though the mercurial US president negotiated what he said was the best trade agreement ever.
Spot: MXN18.1188 (MXN17.2270) Median Bloomberg One-month forecast: MXN17.9743 (MXN17.60) One-month forward: MXN18.1655 (MXN17.2765) One-month implied vol: 13.9 (9.2%)
Chinese Yuan: China seems like one of the few beneficiaries of the US-Israel war on Iran. The disruption in the energy market may boost the demand for solar panels and electric vehicles, which China dominates. While China bullies its neighbors, a tragedy of small countries next to large ones, it has shown restraint compared with Russia and the United States. Ships carrying Iranian oil to it have not been molested in the Strait of Hormuz. Reportedly, Tehran is encouraging others to pay for oil in yuan for safe passage. The stability of its onshore bond market has drawn renewed interest from some global asset managers. Beijing is lifting all tariffs on more than 50 African countries, which offers stark contrast with the US broad tariff regime. Nor has Beijing used the broad gains of the greenback since the start of the war to depreciate the yuan. At the end of the third week of the war, the PBOC set the yuan's reference rate against the dollar at its strongest level since April 2023. Still, the rise in oil and food prices may help offset the disinflationary forces in China, it will do nothing to stimulate demand. The offshore yuan is consolidating in a roughly CNH6.86-CNH6.95 range. The dollar bottomed against the onshore yuan near CNY6.8315 in late February. We suspect it can fall to CNY6.70-CNY6.75 later this year, which is somewhat more bullish than the consensus. However, first, the PBOC will not ignore the dollar's broad strength amid the hostilities with Iran. Instead, it may acquiesce to the greenback's strength and allow it to recover back into the CNY6.9250-CNY6.9500 area.
Spot: CNY6.9112 (CNY6.8620) Median Bloomberg One-month forecast: CNY6.9067 (CNY6.9250) One-month forward: CNY6.9145 (CNY6.8830) One-month implied vol: 3.7% (3.4%)
Reviewed by Marc Chandler
on
March 28, 2026
Rating:
