Good morning. Oil prices are up nearly 15% from Friday’s close and the dollar is retreating after an escalation between Washington and Tehran led to a collapse in shipping through the Strait of Hormuz, again threatening global energy supplies. After a series of Iranian attacks on shipping and military skirmishes, President Trump yesterday reinstated a naval blockade on Iran, declaring the United States would become the Strait’s “guardian” and that it “will remain open, with or without Iran”. He also announced a 20% fee on all cargo transiting the waterway*—a levy that would materially raise the cost of a barrel of oil and risk unleashing another round of inflation pressure across the global economy. Iranian Foreign Minister Abbas Araghchi replied on Twitter, saying “POTUS is absolutely right. Whoever provides secure and safe passage of commercial vessels through the Strait of Hormuz should be compensated for this service. 20% is of course too much. We will be fair.”

Federal Reserve governor Christopher Waller has raised the stakes ahead of this morning’s consumer price index print in spectacular fashion**, warning that another elevated core inflation reading could force the central bank to raise rates imminently. “We’re building off of, basically, almost six months of higher, higher, higher, higher,” price growth, Waller told the New York Association for Business Economics yesterday. “Another higher one? I’m gonna treat that as signal”. “Sternly staring at inflation until it melts before our withering gaze is not an option,” he said, “If we get another hot reading on core inflation this week, then the FOMC (Federal Open Market Committee) will need to consider tightening monetary policy in the near term”.

Interest rates have jumped in response, with two-year Treasury yields at their highest since last February and curves moving up in sympathy across the developed economies. Traders are now putting roughly 40% odds on a rate hike at the July Fed meeting, up sharply from a week ago, and tightening expectations have risen across the front end of the curve. Money markets see the Bank of England delivering one move this year, with the European Central Bank expected to hike at least once, perhaps twice, before year-end.

Uncertainty ahead of this morning’s print is high. Economists generally think core inflation rose 0.2% in June—the same as the prior month — but there is considerable dispersion around that estimate, with at least one major bank pencilling in a 0.4% print. We believe pressures should ease outside semiconductor-driven categories and the World Cup-inflected hospitality sector as shelter costs continue to soften and the effects of last year’s tariff increases fade. But the Fed has recently gathered evidence suggesting the tariff passthrough is not yet complete: almost half of firms that have paid the levies are still planning additional price increases. And the recent surge in oil prices raises the risk that the disinflationary process we have been counting on may not arrive on schedule.

For currency markets, this adds up to a dangerous operating environment. As suggested in yesterday’s missive, a “mean reversion” process is playing out, with the dollar retreating from overvalued levels amid a broader reckoning with the risks facing the world’s most powerful economy—but with the Fed suddenly edging toward a July hike, widening rate differentials ought to be pulling capital in; that they aren’t suggests traders have concluded Washington is the author of this crisis rather than a refuge from it. If that conclusion holds, traditional correlations with risk assets and commodity prices could be thrown into disarray.

*This update in the ‘Pirates of the Caribbean’ franchise is missing something… perhaps Keira Knightley?

**Use of the word “spectacularly” admittedly sounds hyperbolic when applied to anything that a central banker says, but it is highly unusual to see a sitting Fed official highlighting a single data release in this way.