Good morning. Oil prices are climbing and the dollar is trimming its losses against major peers as hopes for a near-term diplomatic resolution to reopen the Strait of Hormuz fade amid a fresh round of military escalation in the region. The US military struck targets in southern Iran and sank two Islamic Revolutionary Guard Corps vessels last night in what American officials described as defensive operations, while Israel simultaneously launched air strikes against Hezbollah in southern Lebanon.

The reversal follows a long weekend that had brought a string of optimistic headlines, easing pressure across asset classes. President Trump announced on Saturday that a pact to reopen the Strait was nearing “finalisation”, though Iran contradicted this, leading him to temper expectations on Sunday—instructing his representatives not to rush and confirming the US blockade on Iranian shipping would remain in place—before posting yesterday that negotiations were “proceeding nicely”. With two sides remaining far apart on the basics—management of the Strait and handling of Iran’s nuclear material—markets are taking a skeptical view*.

Markets are betting the Federal Reserve will raise borrowing costs by December as officials seek to prevent a second inflationary overshoot in five years. Although last night’s open brought a modest unwind, traders in fed funds futures markets are still almost fully pricing in a quarter-point increase by the end of the year after Governor Christopher Waller said on Friday that he supported a move away from the “dovish bias” that has long characterised the central bank’s communications. “It’s just kind of crazy to say ​you could start talking about rate cuts in the near future” with inflation running above target and labour markets displaying no evidence of a sharp slowdown, he said, “You just can’t look at this data and say we could cut rates by September or something … you can’t ​be serious as a central banker and talk like that”.

Data this week could further widen the US rates divergence with other major economies. Although today’s Conference Board consumer confidence survey may show higher gasoline prices weighing on household sentiment in May, stable labour market conditions should limit the damage. On Thursday, the Bureau of Economic Analysis is expected to confirm an acceleration in underlying price pressures, with the Fed’s preferred measure—the core personal consumption expenditures index—rising 0.27% in April, lifting the year-over-year inflation rate to 3.3% from 3.2%. Consumer spending and personal income are both seen advancing 0.5% on the month, supported by tax refunds, strong wealth effects, and still-solid wage gains. The durable goods orders report, released at the same time, should show substantial gains from Boeing’s China-fattened order book and ongoing semiconductor investment.

Growth elsewhere remains moribund, with soaring imported energy costs hitting already-soft economies in the United Kingdom, the European Union, and Japan. Yields have tracked inflation expectations higher in all three blocs, but the pound, euro, and yen are displaying increasingly negative correlations with US two-year yields as investors simultaneously price in larger downside risks abroad and raise expectations for the US. To us, this suggests that the dollar’s decline on an eventual peace agreement could prove more limited and less sustained than many anticipate.

The Canadian dollar remains stubbornly range-bound ahead of Friday’s first-quarter gross domestic product report, which is expected to show the economy staging a relatively modest recovery after contracting at the end of last year. Output is forecast to have grown at a 1.5% annualised pace in the first three months of 2026, following a 0.6% contraction in late 2025, with government spending, investment, and household consumption helping offset continued weakness in exports. An advance monthly estimate for April will offer insight into the strength of the handoff to the second quarter.

Paired with evidence of soft labour markets and weak demand-led inflation, this growth backdrop should give the Bank of Canada room to await clearer evidence of a shift in economic direction before moving again. Markets are placing near-zero odds on a hike at the central bank’s next meeting on June 10 and have revised expectations for the rest of the year downward, with overnight index swaps now pricing in 34 basis points of tightening by year-end, down from almost 80 in mid-March. At least four plausible scenarios could play out in the coming months—a muddle-through resembling the current environment, an acceleration in growth, a stagflationary rise in prices, or a softening in both output and labour markets—but it is too early to tell which will prevail. Officials are likely to wait before pivoting toward a hawkish communications regime.

*A dynamic perhaps best summed up in this very funny tweet.