Markets Pricing out Conflict?

MACRO FRAME

Markets are pricing out the war premium, with the dollar closer to its pre-war level and the S&P notching a record close on Wednesday. Markets are looking past the conflict and pricing a settlement between the US and Iran, leaving earnings season to play a more dominant role in determining risk sentiment.

STOCK INDEX FUTURES

US equity index futures are higher overnight. There is growing confidence among investors that the US and Iran will return to the negotiating table in the coming days. That belief has spurred the recent rally, which saw the S&P close above 7,000 for the first time ever, while the Nasdaq has notched 11 straight gains for the first time since November 2021, while also closing above 24,000 for the first time. Iran’s non-action is the daily bullish catalyst for the indexes under current conditions, while a confirmed Iranian strike on Gulf infrastructure would trigger a reversal of current momentum.

Bloomberg had previously reported that Washington and Tehran are considering a two-week ceasefire extension. People familiar with the discussions say mediators are seeking fresh talks to overcome sticking points on the Strait of Hormuz and nuclear enrichment, with both sides preferring to avoid a return to active hostilities when the current ceasefire expires April 21

Q1 earnings season is off to a strong start, the S&P 500 entered the reporting period expected to deliver 13.2% YoY earnings growth, which would mark the sixth consecutive quarter of double-digit growth, and FactSet estimates the actual rate could land near 19% once beats are fully tallied, the highest since Q4 2021. The early wave has been dominated by financials, where every major bank beat on both the top and bottom lines as their trading desks capitalized on war-driven volatility, while credit has held up better than feared. So far, the solid performance reinforces the view that the S&P 500 earnings backdrop remains fundamentally strong even against the geopolitical overhang

Watch point: The ceasefire has reduced geopolitical tail risk and spurred optimism that the US and Iran will meet at the negotiating table again, providing markets with a bullish catalyst.

CURRENCY FUTURES

US DOLLAR: The USD index is 0.13% higher at 98.18, following a rise in oil prices overnight. The main catalyst for USD remains the direction of oil prices and developments between the US and Iran. As evidenced by previous moves, any signs of de-escalation and diplomatic off-ramps will renew pressure on the dollar, while any escalation points towards more safe haven demand.

Underlying fundamentals make the case for a resumption of the dollar’s downward trend once hostilities in the Middle East are officially over. Despite rising inflationary pressures driven by energy prices, the dollar has lost its interest rate differential support it once drew from hawkish Fed expectations, support that has since been repriced away. With the labor market softening materially, the underlying case for a Fed rate cut later in the year remains intact.

Watch point: Despite March’s hot inflation print and a sticky February PCE reading, a move up from the Fed is out of the picture as the Fed is well positioned in its policy rate for the time being, though a weak labor market leaves the door open for easing.

EURO: The euro fell 0.16% to $1.1781 overnight. Developments regarding the ceasefire between the US and Iran remain the dominant factor in price direction for the euro. European Central Bank President Christine Lagarde on Tuesday said the euro zone’s economy is somewhere between the ECB’s baseline and adverse scenarios, adding the central bank would be “agile” when setting interest rates. The risk of a prolonged rise in energy prices makes a more appeal case for a hike at the June meeting. Markets are fully priced for a rate hike at the June meeting and see one more rate hike by year end. The path to tightening from the ECB will hinge on the effectiveness of the two-week ceasefire and whether it brings lasting peace. The critical risk factor is the persistence of the energy shock.

Watch point: March’s inflation data confirmed that headline inflation was dragged higher by rising energy prices, while other components were reassuring to the broader inflationary picture. A rate hike at the ECB’s April meeting is unlikely, while the case for tightening depends on the effectiveness of the ceasefire and duration of the rise in energy prices.

BRITISH POUND: Sterling is 0.11% lower at $1.3543 as the rise in oil prices overshadowed February’s GDP data overnight. UK real GDP grew by 0.5% MoM in February, and by 0.5% in the three months to February compared with the three months to November 2025. All three major output sectors, services, production, and construction, contributed positively in the month. On a YoY basis, GDP is estimated to have grown 1.0%. Q3 and Q4 2025 quarterly GDP were both revised down from +0.1% to 0.0%, a softening of the late-2025 picture.

Price direction in FX markets continues to be dominated by developments from the US-Iran conflict, mainly oil prices given Britain’s dependence on energy imports and the economy’s sensitivity to higher energy costs.

Markets continue to expect an upward move in BoE policy, with a rate hike by September fully priced in. However, expectations for year-end policy have fallen dramatically in recent days, markets are now pricing 35 bps of tightening, down from 51 bps on Monday and well below over 75 bps of tightening priced at the onset of the conflict. The weakness of the UK economy remains a limiting factor for potential tightening as market-implied odds had overshot realistic BoE policy at the beginning of the conflict.

Watch point: Signs of a diplomatic route between the US and Iran and friendly to the pound, though pre-war macroeconomic factors could resume their pressure on the currency if hostilities find a quick end.

JAPANESE YEN: The yen is little changed at 159.04 yen per dollar. Japan’s finance minister said Japan and the US agreed to intensify communication on exchange rates after her meeting with Treasury Secretary Scott Bessent on Wednesday. Markets continue to scale back pricing for a rate hike this month by the Bank of Japan, though remain favorable to a hike at the bank’s July meeting. The Yen has failed to hold a depreciation past the 160 level, as expectations of government intervention and eventual policy tightening offer support. The yen’s near-term trajectory remains hostage to geopolitical developments, a durable ceasefire could quickly unwind oil-driven inflation expectations and reduce urgency for BoJ action, though the bank is set to maintain its tightening bias.

Watch point: An April rate hike could pull USD/JPY closer to 155, though the odds of such happening appear unlikely at the time being.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.7174, holding near a one-month highs as labor data overnight showed employment rose in March, while the jobless rate remained low, firming support for a May rate hike. Meanwhile, market optimism that the US and Iran will return to the negotiating table is also likely to support risk sentiment and the AUD. Markets imply a 72% chance of another quarter-point rise in May, and see rates at 4.63% by year-end (+53 bps). While a durable ceasefire would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to keep the RBA on a tightening path.

Watch point: The RBA is likely to maintain its tightening bias amid persistent inflationary pressures.

TREASURY FUTURES

Yields are little changed, though the curve has steepened slightly overnight. The bond market appears to have priced out geopolitical risk associated with the Iran conflict, as the 10-year yield has stabilized near 4.28% in recent sessions after touching a local high of 4.44% in late March. Longer-run inflation expectations at the time-being offer resistance to higher yields as the Fed should remain biased towards policy-easing given weakness in the labor market. The 1/2-year inflation swap spread rose to 37.63 bps, in line with expectations that markets are expecting the impact of higher energy prices to be short-lived.

However, the rise in energy prices does complicate the case for policy-easing if a durable ceasefire and end to hostilities cannot be agreed to. That said, the NY Fed’s March 2026 Survey of Consumer Expectations showed 3-year inflation expectations rising only a modest 0.1 ppt despite the largest monthly gasoline spike on record. Longer-run inflation expectations remain central to Fed policy, meaning that anchored expectations will support the case for policy easing later in the year. With 2-year swaps near 2.75% and no evidence of sharp rises in longer-horizon measures, markets are not pricing a scenario that requires a policy response from the Fed. We maintain our outlook for one Fed rate cut in 2026.

Watch point: Following March’s labor and inflation data, an immediate case for a change in Fed policy remains unlikely, while a path to loosening remains open.

The spread between the two- and 10-year yields is 51.50 bps, while the two-year yield, which reflects short-term interest rate expectations, is 3.757%.

 

 

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