Despite the hardening rhetoric of the Trump administration regarding control over the Strait of Hormuz, traditional market reactions are misfiring. Rising energy prices no longer translate into a rally in US Treasury yields, as was observed at the onset of the geopolitical crisis. On the contrary, declining government bond yields are putting downward pressure on the US dollar, opening room for the EUR/USD pair to rise.
The dominant market narrative suggests that even if Brent prices continue to climb, they are unlikely to reach March highs. The oil market has demonstrated remarkable adaptability: alternative logistics routes have been secured, and demand has structurally adjusted. If the peak in energy prices has already passed, it is highly probable that the peak of US inflation is also behind us. This thesis is supported by both fresh Producer Price Index (PPI) data and recent comments from Federal Reserve officials.
A 0.3% month-over-month decline in the PPI allows us to project that the Fed’s preferred gauge—the Personal Consumption Expenditures (PCE) index—rose by a mere 0.1% to 0.2% in June. Such restrained dynamics give the central bank solid grounds to maintain a pause in monetary policy. New York Fed President John Williams noted that the current interest rate level is adequate to contain price pressures, adding that the oil market has, in his view, already passed its peak. Similar logic applies to “AI inflation”: against the backdrop of gradually cooling hype around artificial intelligence technologies, this factor may also exhaust its inflationary potential.
In his testimony before Congress, Fed Chair Kevin Warsh emphasized that AI’s impact on the macroeconomy is not necessarily inflationary. Undoubtedly, colossal capital investments in new technologies have already exerted upward pressure on prices, but the key question remains: what will happen over a 12-month horizon? Will this effect be neutralized by expected gains in labor productivity?
The combination of these factors—moderate CPI and PPI dynamics, expected PCE deceleration, and public statements from FOMC officials indicating that inflation has peaked—has forced the derivatives market to radically revise its expectations. In just two days, the probability of monetary policy tightening in July plummeted from 40% to 10%, while the odds of two rate hikes in 2026 dropped from 58% to 29%. This precisely explains the observed divergence: whereas oil and government bond yields previously moved in sync, their trajectories have now parted ways.
This configuration is exerting noticeable pressure on the US dollar. At first glance, this appears paradoxical: the greenback is not receiving traditional premiums either as a safe-haven asset or as the currency of a net energy-exporting nation. However, market logic is straightforward: if the US equity market was able to fully price in and adapt to the Middle East conflict by April, there are no fundamental reasons why the Forex market could not do the same.
