Good morning. Oil prices are extending their gains as the conflict in the Middle East intensifies, and the dollar remains on the defensive after yesterday’s June inflation report came in well below forecasts. President Trump reimposed a naval blockade on all Iranian ports yesterday, and Tehran threatened to close “all other export corridors that benefit the US and its allies”—language widely interpreted as a signal that Iran intends to use its proxies in Yemen to shut the Bab el-Mandeb strait, the chokepoint between the Red Sea and the Indian Ocean through which a further 14% of global trade passes. Brent is up 17% this month and West Texas Intermediate has risen 15%. North American equity futures are pointing to gains at the open, yields remain lower, and all major currencies are posting gains against the dollar.

Underlying inflation pressures eased across the American economy last month. Excluding food and energy, core prices declined slightly in month-on-month terms for the first time in more than five years, with the softness broad-based: core services prices were flat, down from a 0.3% gain in May, while core goods inflation turned negative, suggesting that tariff pass-through has largely run its course. This morning’s producer price data should shed further light on cost-push dynamics ahead of the personal consumption expenditures update at month-end, but market-implied inflation expectations have fallen sharply, with breakevens pointing to a disinflationary impulse powerful enough to offset a renewed energy shock.

Monetary tightening expectations have undergone a radical reappraisal. Fed officials will need more evidence before signalling a change in direction, but odds on a July hike are down to less than 15% from 41% ahead of the release, and the central bank’s first move is now not expected until October—a month later than previously anticipated.

Barring an unexpected misstep, this morning’s Bank of Canada decision should leave currency markets unmoved*. Governor Macklem and his colleagues will almost certainly leave policy on a moderately-accommodative footing and repeat their pledge not to let higher energy prices become persistent inflation. The accompanying forecast update should show the economy rebounding in the second quarter and generating slightly stronger growth through the remainder of the year, with labour markets tightening amid little evidence of a demand-led broadening in price pressures. In our view, the loonie’s direction will continue to be determined more by changes in oil prices*** and flows into US capital markets than by any shifts in domestic fundamentals.

Even after yesterday’s correction, most major currencies remain stuck at technically oversold levels against the dollar, pointing to a lack of conviction among foreign exchange participants. Foreign investment flows into American financial assets totalled $1.66tn in the year to May, only slightly below April’s record $1.71tn, with artificial intelligence-related equities likely accounting for a lion’s share. This headlong rush of capital into US markets remains, in our view, the biggest risk to currency markets in the second half of the year. A sudden pullback in optimism around the technology boom could pose a meaningful threat to the dollar, with some of the currencies currently screening as oversold potentially emerging as the primary beneficiaries.

“They couldn’t hit an elephant at this dist…”—the last words of John Sedgwick, Civil War general, shortly before being shot in the head.*

**”Look Tony, what are the odds of a prime minister being drowned or taken by a shark?”—Harold Holt, Australian Prime Minister, shortly before death by drowning or being taken by a shark.

***Note that this is on the margins. Correlations between oil prices and the Canadian dollar have fallen dramatically in recent years, but still emerge during episodes of high volatility.