Good morning. The dollar is holding firm as a new outbreak of hostilities in the Middle East sends oil prices to their highest since late July, raising the stakes ahead of Friday’s US inflation report—and next week’s Federal Reserve meeting. Brent crude, the global benchmark, is holding near $100 a barrel after the US and Iran each attacked oil tankers over the weekend, and Yemen’s Iran-backed Houthis struck energy facilities and cities across Saudi Arabia. Ten-year Treasury yields are near levels last seen in January 2025, equity futures are pointing to a weaker open, and speculators are paring long bets on the greenback at a more measured pace as they brace for volatility ahead.

This week’s inflation report could prove pivotal in determining whether the Fed raises rates next Wednesday. Friday’s non-farm payrolls data cleared the way: job creation re-accelerated in August, with employment jumping by 162,000*—a sharp reversal from July’s drop—while the unemployment rate held at 4.1%. But there is considerable uncertainty around how price pressures are evolving, with some economists expecting continued moderation in core measures of inflation while others brace for a rebound as high energy costs generate knock-on effects in other categories. Christopher Waller, a Fed governor often seen as a bellwether for the centre of the rate-setting committee, said on Thursday that “continued progress towards our 2% goal” would be make him “willing to support holding the policy rate at its current level”, but also added that a pickup in inflation could lead him to consider a hike. With markets putting the odds of a move around 60%, a mild print is likely to trigger a pullback, while an upside surprise could see probabilities spike to near-certain levels.

The euro is edging lower after the hard-right Alternative for Germany (AfD) scored its best-ever result in a state election, taking 43.8% of the vote in Saxony-Anhalt—more than double its 2021 share—and finishing well ahead of the Christian Democratic Union (CDU), which slumped to 17.2%. The party’s victory in Germany’s smallest and poorest state is unlikely to trigger a leadership challenge against Chancellor Friedrich Merz, but will strain his federal coalition, with further losses at the state level complicating economic reforms and endangering approval of next year’s budget—further dimming already-slim odds that last year’s fiscal stimulus push will generate a sustained growth impulse sufficient to lift the broader European economy**.

Markets have fully priced in a rate hike from the European Central Bank on Thursday, so attention will be focused on its updated growth and inflation forecasts. There has been little sign of second-round price effects, but amid a series of war- and climate-related energy shocks, wage growth has picked up, and inflation is now expected to reach target later than previously thought. Although policymakers led by Christine Lagarde are likely to reaffirm their meeting-by-meeting, “data-dependent” approach, a run of hawkish appearances from Governing Council officials would suggest that they may hint at another move in December—which would help keep the euro well-supported near current levels.

The yen is pushing past the levels it reached during the US-Japanese intervention in early August. There is no clear evidence of an official role in this bout of appreciation; and although stronger output and real-wage numbers are lifting expectations for rate hikes from the Bank of Japan later this month and into next year, positioning adjustments may be playing an equally important role. We suspect speculators are unwinding carry trades—trades in which participants borrow cheaply in yen and buy higher-yielding currencies—while front-running expected shifts in capital outflows from pension and life-insurance funds. With no clarity on how large those positions are, the move could have further to run.

Here in Canada, the loonie is shrugging off the weekend’s escalation in tensions with the Trump administration. In a series of posts on his social media platform, the US president called Canada’s “dollar imbalance”*** with the US “unacceptable” and threatened to cut off Bombardier’s access to US markets****. This morning, Canada imposed “dollar-for-dollar” tariffs of between 15% and 50% on roughly $20bn in imports from the US, retaliating against the 50% tariffs imposed by the administration in late August.

The currency’s calm is somewhat surprising. Against such a negative rhetorical backdrop, we had expected Canadian households and firms to turn more cautious in the months ahead, weighing on growth and the exchange rate. But Friday’s weaker-than-expected jobs report has not fundamentally altered the outlook: a range of activity indicators still points to a gradual improvement. The Bank of Canada was far less dovish than expected last week, downplaying trade-related risks to the economy and stressing the danger of higher inflation should energy prices stay elevated. Although tariffs will hurt targeted businesses and sectors, broader export volumes should hold up as long as the US keeps borrowing and spending on a vast scale, and continues its adventures in the Middle East—both of which help keep demand and commodity prices high. It’s a low-conviction view, but softness in the loonie may have already passed, with risks tilting to the upside into year end.

*One of our favourite economists has cast serious doubt on this number, but the fact remains that the US labour market remains tight from a longer-term standpoint.

**The euro climbed sharply last year when Chancellor Merz’s government announced a major expansion in German spending on defence and infrastructure. The rollout has proven underwhelming.

***There is an “imbalance” at work. The loonie has underperformed the dollar for much of its history: Canada’s weak productivity and its structural dependence on commodity exports leave the exchange rate hostage to volatile resource prices, while a more diversified, tech-heavy, and reserve-currency-powered American economy steadily widen the growth and yield gap, drawing capital south. But Trump’s tariff threats have widened the divergence further—weighing on the outlook for Canadian exports, raising investment uncertainty and pushing the Bank of Canada towards easier policy. This contradiction is apparent across policy vectors, with trade and Treasury actions often working against each other.

****Other posts showed the president posing with legendary generals Patton and MacArthur, topping a list of American presidents, Canada and Mexico becoming US territory, New Mexico becoming “New America” and the moon belonging to the US. It was a busy weekend in the White House social media office.