US CPI: Cooling core inflation faces war risks
Financial markets showed a muted reaction to the latest US inflation data. Treasury yields ticked just a tad higher, with two-year yields rising a single basis point, while stock futures remained flat. The February Consumer Price Index landed exactly in line with forecasts across the board. Both headline and core CPI met expectations, with the core year-on-year rate coming in at 2.5%. This slight slowdown from January is exactly what Federal Reserve policymakers have been hoping to see. In fact, this 2.5% core rate marks the lowest level of inflation since the initial cost-of-living surge began in March 2021. Therefore, it is hard to see this release nudging the central bank’s policy debate in any meaningful way.
However, this encouraging snapshot of February comes with a caveat. Because this data was collected before the recent outbreak of the Iran war, these numbers already feel old. February’s inflation numbers were heading in the right direction, but the surge in energy prices has drastically changed the global economic landscape. Furthermore, US food inflation faces severe future risks from the conflict. More than a third of the global fertilizer trade passes through the vulnerable Strait of Hormuz. Consequently, investors and policymakers are now bracing for how the war will inevitably alter the inflation trajectory in the months ahead.
Markets will look through these numbers, which came in as expected, and continue focus on the energy markets and react to the upcoming headlines from the Middle East.
CAD’s ‘exceptionalism’, for how long?
Since the start of the US and Israeli operations in Iran on February 28, the Canadian dollar has functioned as a primary vehicle for the “energy dependence trade,” though its response is more complex than a simple “petrocurrency” label suggests. Market literature indicates this relationship is highly regime-dependent and currently sits below historical point estimates. Some academic models have previously found an elasticity closer to 0.3, where a 10% oil rally would trigger a 3% CAD appreciation. The current, more muted beta likely reflects the fact that this is a fear-led supply disruption rather than a demand-led global boom, meaning the currency’s upside remains somewhat capped by broader USD dominance and geopolitical uncertainty.
The Loonie has nonetheless outperformed all major G10 peers, providing a temporary shield against lackluster domestic data. For instance, the CAD has seen a significant 2.1% jump against the Euro and a 1.8% rise against the Japanese Yen as energy costs pressured those regions. This “Canadian exceptionalism” has allowed the currency to decouple from the broader malaise affecting other major economies, essentially using the $155 billion value of its crude exports to offset trade frictions with the US. However, the geopolitical “fear bid” will likely be momentary, especially when the underlying domestic indicators suggest the economy is skating on increasingly thin ice.
Beneath this oil-slicked surface, the domestic credit market is beginning to show fractures that threaten to undermine the currency’s gains. The recent 57% plunge in shares of goeasy, a Canadian subprime bellwether, serves as a startling “canary in the coal mine” for the broader financial system. With subprime loan defaults surging to 12.9%, the risk of contagion is shifting toward the housing sector, where mortgage arrears are already climbing from historic lows. This trend is particularly acute in major hubs like Toronto and Vancouver, where arrears are projected to increase steadily through 2026. These internal stresses suggest that while high oil prices support the currency externally, the structural foundations of the Canadian economy look weak.
Ultimately, the Loonie’s current strength is plausible only as long as the Middle Eastern risk premium remains intact. While data from the EIA and international monitors may justify the rally, the currency’s true staying power hinges on the stability of domestic credit and internal growth. If a credible de-escalation occurs, oil prices will likely retrace, removing the pillar currently supporting the CAD through Q1. Once the geopolitical fog clears, the market will inevitably refocus on the consumer landscape, the CUSMA deal review and the rising default rates in the housing market. The Canadian dollar’s period of dominance is likely to prove short-lived as the cold reality of a sluggish domestic economy catches up with external volatility.
GBP: Next test sits near $1.35
UK gilts have swung violently over the past 48 hours, with both the short and long end outperforming peers after Trump hinted the Iran conflict may be nearing an end. The UK had carried one of the largest geopolitical‑inflation premia in G10 rates, and once energy prices retreated, that premium unwound quickly, whilst sterling has strengthened against most majors bar the Antipodeans.
Two‑year gilt yields surged as much as 25bps on Monday as markets briefly priced in around 18bps of BoE tightening for 2026 — a remarkable shift given that, before the conflict escalated, money markets were fully pricing two quarter‑point cuts this year. This sensitivity reflects the UK’s still‑elevated inflation backdrop: headline is 3%, services remain sticky, and the Bank has been reluctant to accelerate easing despite its dovish tilt in February. That arguably makes the UK curve more exposed to energy‑driven inflation scares.
But the UK’s terms‑of‑trade hit from higher energy prices is arguably not as severe as Europe’s, thus markets possibly over‑priced the inflation risk. Hence, when crude and gas prices tumbled on Tuesday, the front end retreated as traders leaned back toward a BoE cut rather than the hike priced only a day earlier. The long end followed, helped by a compression in the fiscal‑risk premium that had widened during the initial shock.
in FX, the pound has joined the broader rebound against the US dollar, carving out a clear technical base after repeatedly failing to close below $1.3356 despite last week’s slide to $1.3253. That resilience suggests sellers have struggled to extend the downside even amid the fog of war. With the immediate dollar squeeze easing, attention now shifts to the next resistance level near the 21‑day moving average around $1.35. Still, the dollar’s reversal remains tightly bound to energy markets: oil needs to start flowing again for this move to extend. What matters most is a reopening of the Strait of Hormuz and a restart of Middle Eastern production — without credible headlines pointing to a ceasefire or de‑escalation, the greenback is unlikely to surrender the gains accumulated over the past two weeks.
Against the euro, sterling has outperformed. The hawkish repricing in BoE expectations has been far more pronounced than the ECB’s, reinforcing GBP/EUR strength alongside the positioning dynamics we highlighted yesterday. That swing has left GBP/EUR better anchored than might be expected in a geopolitical shock of this magnitude.
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
