Iran’s Foreign Ministry said they are “not signing any agreement with the US” and that “no one can claim we are close to reaching an agreement” until there is clarity regarding its nuclear programme. Iran separately told Tasnim News Agency that they are now on the verge of “cancelling” the negotiations completely.

And this morning, we wake up to news that the US struck targets in Iran — while Russia told the US to evacuate its diplomats and citizens from Kyiv.

As a result, US crude — which had tanked more than 7% to $90pb — rebounds this morning above $93pb. Yields are also coming under pressure. The Japanese 10-year yield, closely watched in the context of a potential yen carry unwind, fluctuates near 2.70%, while the US 10-year yield returns from the long weekend after dipping below 4.50% and is now inching higher again.

So we continue to go round and round. It’s frustrating because US officials are playing with markets and the narrative the way a cat plays with a mouse, and there is very little investors can do about it.

Moving forward, and given the chaotic track record of negotiations throughout this Iranian conflict, I would say that we could easily see US crude return above $100pb if peace talks fail to move in the right direction and traffic through the Strait of Hormuz is not quickly restored.

And as we approach the third month of the conflict, every additional day is pushing the physical market toward pain levels not yet seen during this crisis. That means heightened volatility and potentially sharp upside moves as markets prepare for a prolonged period of constrained oil supply, while global oil inventories continue to decline at record speed. I still believe that $120pb+ will continue to act as the level that tilts the balance of the market narrative toward “demand destruction,” limiting the sustainability of any spike beyond those levels. But until then, tactical longs still have room to play.

Inflation watch

Now, we always come back to the same subject. Rising oil prices have been fuelling inflation expectations across the globe, putting upward pressure on global yields — in some places to levels not seen since the subprime crisis, and in others to levels unseen for decades.

Although most — if not all — central banks are considering tighter monetary policies to fight rising inflationary pressures, the sensitivity of economies to energy prices remains highly uneven, leading to interesting divergences and opportunities across FX markets.

Energy importers like the UK and the EU are clearly among the most sensitive economies, where central banks will likely react more aggressively to rising price pressures than those in energy-exporting countries. The latest inflation figures from the UK may have offered some relief to hawkish Bank of England (BoE) expectations, but that does not change the fact that if the Middle East conflict continues, the only thing that could spare UK markets from further rate hikes may be a severe economic meltdown.

The same applies to European economies, where government debt continues to rise while GDP growth remains sluggish.

I came across an interesting chart showing how German government consumption is rising faster than capital investment and GDP, suggesting that many Western economies today are increasingly running on government debt that becomes more unsustainable by the day.

Inflation is clearly one of the best ways to erode the real value of debt away, yes, but it also slowly erodes purchasing power, distorts capital allocation and keeps long-term borrowing costs structurally higher. And when debt finances consumption rather than productive investment, it becomes much harder to generate the growth needed to stabilise the debt burden over time. Ask Brits if you don’t believe me.

Eventually, markets begin questioning not only the sustainability of the debt itself, but also the credibility of the economic model supporting it.

So it is in this context that we are preparing to discover the latest inflation figures from Australia and the US this week. Inflation in Australia is expected to stabilise near 4.4%, slightly lower than the 4.6% printed a month earlier, while the US core PCE index — which jumped to 3.5% from below 3% at the previous release — is expected to ease slightly to 3.3%.

But price pressures were already sticky before the Iranian war, and the longer the conflict drags on, the higher the risk that elevated energy prices become entrenched by feeding into other components of inflation — especially wages and transportation costs — making inflation even stickier and more difficult for central banks to contain.

Last Friday, activity in Federal Reserve (Fed) funds futures pointed to roughly a 56% chance of a December rate hike, versus the two to three rate cuts that were expected before the Iranian conflict began. This hawkish shift in Fed expectations has been drowned out by an even more hawkish repricing of expectations for other major central banks, helping keep the US dollar in check.

But a renewed rise in oil prices could give the US dollar another boost. A stronger US dollar would further fuel inflationary pressures elsewhere and weigh on currency valuations before the interest rate differential eventually works in their favour. In simpler terms, I would expect EUR/USD and Cable to remain under pressure if the Middle East conflict continues and oil prices fail to retreat.

And for equity markets — both EM and DM — rising borrowing costs are screaming for attention, as tighter financial conditions are becoming increasingly difficult for investors to ignore. Higher global yields raise the cost of capital, pressure valuations and threaten to slow both consumer spending and corporate investment.

A chart from Oxford Economics actually summarises how technology stocks are distorting our perception of what’s really happening beneath the surface. Strip out companies like TSMC, Samsung Electronics and SK Hynix, and emerging market valuations have fallen back to the depressed levels seen during last April’s Liberation Day dip.

The question is whether a handful of mega-cap technology companies can continue soaring toward the moon while much of the global economy remains stuck in hell.