Oil prices have tumbled and the dollar is trading near a two-week low after Washington and Tehran announced they had reached a tentative agreement to pause the war in the Middle East and reopen the Strait of Hormuz. Pakistani Prime Minister Shehbaz Sharif, who brokered the final round of talks, revealed the deal, President Trump announced it on social media, and semi-official Iranian media outlets confirmed it. The full terms remain undisclosed, but the broad outlines are becoming clear: the US will relax sanctions on Iranian oil and petrochemicals, both sides will lift their shipping blockades, and negotiations on Iran’s nuclear programme—Trump’s stated reason for beginning the war—will be postponed. Failing a renewed escalation in the conflict, the two sides are expected to sign a memorandum of understanding in Switzerland on Friday.

All major currencies are extending their gains against the dollar, with the biggest moves coming from the energy importers—the euro, Swiss franc, pound, yen and peso—which stand to benefit most from a reopening of the Strait and the easing in oil prices it could bring.The Canadian dollar remains a laggard, with the negative terms-of-trade hit helping offset a broader improvement in risk appetite.

Major uncertainties remain. The agreement must navigate Israeli opposition and resistance from Iranian hardliners while the 60-day negotiation window remains open, and although Trump has said the strait will be toll-free, Tehran insists it will control the waterway jointly with Oman. Decades of history would suggest that nuclear enrichment activities—and the disposal of existing stockpiles—could remain a major sticking point.

Oil benchmarks are unlikely to fully return to pre-war levels in the near term. Tankers stranded inside the Gulf during the blockade are expected to begin moving almost immediately, gradually resupplying global markets over the next 60 to 90 days, followed by a wave of vessels entering to retrieve oil from onshore storage. Restarting production fields, refineries and export terminals after prolonged outages is complex, and infrastructure damage sustained during the war could take months or years to repair. Further, Iran has demonstrated its capacity to shut the strait, meaning that higher geopolitical risk premiums will be built in for many years to come.

However, a sustained decline in energy prices should weaken the inflation impulse rolling across the major economies and soften the case for rate hikes from the world’s most powerful central banks. With inflation expectations subsiding, ten-year Treasury yields are already nearing a one-month low and Fed funds futures show eight basis points less tightening than was priced a week ago. The shift is even more pronounced in international markets: while two-year yields have fallen 10 basis points in the United States, they’ve fallen 15 in Germany and 20 in the United Kingdom, underlining the extent to which monetary tightening expectations have been driven by varying degrees of exposure to imported energy prices.

If all else were equal*, this narrowing in rate differentials should be negative for the dollar—but all else is not equal. Speculative positioning has swung sharply in the greenback’s favour, with the aggregate net long dollar position against the eight major currency futures surging to an eight-month high last week. Both headline and core measures of US inflation are running well above comfort and could continue to do so long after the energy shock fades. There are reasons to suspect that consumer spending is running on fumes, particularly in the lower half of the income distribution, but it is difficult to find evidence of an appreciable slowdown. Labour markets remain tight, as the stronger-than-expected payrolls May report confirmed. And as Friday’s oversubscribed SpaceX initial public offering showed, global appetite for US-denominated assets—particularly technology equities—shows no sign of diminishing.

The dollar could gain further support when the Federal Reserve meets on Wednesday in what will be Kevin Warsh’s first meeting as chair. We expect the committee to abandon its easing bias and move into neutral, but to stop short of explicitly signalling rate hikes ahead. The language referring to “additional adjustments” that drew dissent from three regional presidents in April is likely to be removed from the statement, and the ‘dot plot’ could turn more hawkish, reflecting a growing belief among officials that inflation risks have begun to outweigh employment risks, with the median pencilling in no cuts and no hikes this year along with a modest upward revision to the price forecast. If Warsh follows through on previously-articulated views by telegraphing a further reduction in the Fed’s balance sheet, front-end yields could push higher yet.

Against this backdrop, we expect the dollar’s post-war decline to be shallower than—we and others—anticipated a few months ago. Bears may be waiting several months for a sustained recovery in other major currencies to materialise.

‘Ceteris paribus’—meaning “all other things being equal” is a fundamental assumption used in economics to isolate the relationship between two specific variables by freezing all outside influences. It’s fairly useless in a foreign exchange context**.

**As the old bit goes: A physicist, an engineer, and an economist are stranded on a deserted island with no tools, and their only food is a sealed can of beans.The physicist suggests building a fire and heating the can until the pressure builds up and it bursts open.The engineer protests, saying the beans will fly everywhere and get sandy, so they should use saltwater to corrode the metal instead.The economist waves them both off, saying: “You’re both overcomplicating it. First, assume we have a can opener”.***

***If a foreign exchange strategist were also stranded on the island, they’d all be expecting a ship to appear on the horizon within a day or two, and would therefore starve to death.