First Light News: Week ahead: Middle East conflict; central bank announcements and inflation fears

Good morning,

The week that was: A geopolitical firestorm
There is no dressing it up; the past fortnight has been nothing short of extraordinary, super fluid, and very much headline-driven.

What started as a military operation involving the US, Israel, and Iran has since metastasised into a global geopolitical firestorm with profound economic consequences. Brent Crude spiked to highs just shy of US$120/barrel early last week and settled around US$104, up nearly 11.3%. WTI Crude spiked to similar highs, though it concluded the week just south of US$100, up 8.8%.

The IEA described the oil shock as ‘the largest supply disruption in the history of the global oil market’, and stated that member countries are expected to release an unprecedented amount of emergency oil supply – 400 million barrels. To put this into context, this is more than double the amount of oil released in 2022 when Russia invaded Ukraine.

The Strait of Hormuz is key. Approximately 20% of global seaborne oil (including Gas and other refined oil products) has ground to a halt. I borrowed an image from the UN Trade and Development that demonstrates how little traffic is passing through the Strait at this point.

The duration of this war and how long the Strait remains blockaded will decide the ultimate outcome here. Naturally, recession calls have increased, and the longer this conflict lasts, the worse it will be for the economy.

Last Friday’s data delivered a clear message: stagflation. According to the BEA’s second estimate (preliminary), US Q4 25 GDP growth cooled to 0.7% – down from 1.4% in the first estimate – and US January PCE inflation remained elevated with headline and core at 2.8% and 3.1%, respectively. However, while the government shutdown in Q4 reduced spending and influenced GDP, and although we will likely see a bounce-back in growth in Q1 26, the economy’s trajectory is unquestionably trending lower. The combination of elevated prices and lower growth should keep the Fed on the sidelines this week.

The week that is: Geopolitics and central banks in focus
Although geopolitics remains top of mind for investors this week, seven key central bank announcements will share the spotlight. Tuesday features an update from the RBA, while Wednesday includes meetings from the BoC and the Fed. Thursday will see the BoJ, the SNB, the BoE, and the ECB. However, six of these seven central banks are widely expected to keep policy rates steady.

The RBA is the outlier; investors are assigning a 70% probability that the central bank will increase the Cash Rate by 25 bps to 4.10% from 3.85%. This marks a considerable hawkish repricing from around 30% one week ago, aided by stubborn price pressures and recent comments from RBA Deputy Governor Andrew Hauser. He noted that rising energy prices pose an upside risk to price pressures and that the economy is strong in many respects. The OIS curve chart below clearly demonstrates this meaningful hawkish repricing.

LSEG

23 out of 30 economists polled by Reuters also anticipate a hike, while analysts from Westpac, NAB, Citi and Deutsche present a similar view. Despite the rapid rise in rate-hike bets, if the RBA surprises markets this week with a hold or adopts a more cautious stance – such as a dovish hike – it would likely trigger a strong move lower in AUD as traders unwind longs. This is because the AUD is one of the most overstretched currencies to the upside against G10 peers.

Options markets tell a more cautious story. Risk reversals reveal traders are paying a premium for downside protection; a meaningful divergence from spot AUD/USD is evident, which suggests conviction in the rally is far from unanimous. I think this is a case of traders both hedging long positions and looking to outright fade the move.

LSEG

The Fed is widely anticipated to hold the target rate at 3.50-3.75% on Wednesday. As I am sure you have seen, there was an unwind in rate-cut bets recently. From markets expecting the Fed to lower rates twice this year, investors are now pricing in just one rate cut, but barely (-16 bps implied by year-end).

At the core, the Fed’s dual mandate is in a tug-of-war. On one side, we have elevated price pressures, with inflation expectations rising on the back of increasing oil prices, but on the other side, employment growth has taken a sizeable hit, and unemployment has ticked higher. So, I am expecting little in terms of a rate adjustment at the upcoming meeting.

However, I will be closely watching for any shift in language regarding whether they will cut (or hike) rates in the coming months. I would not be surprised if the Fed states it will look past the oil price shock, or treat it as temporary, though this could be a close call given how divided officials are.

The central bank will also release its updated quarterly economic projections. You will recall that the prior dot plot indicated the Fed suggested one rate cut this year, which now aligns with market pricing. Some desks have noted the possibility that the central bank could push this out to 2027 on the back of inflation concerns, which would, of course, increase US yields and provide the USD with extra fuel.

With a busy week ahead, aside from the RBA, which has been covered here, the Research Team will publish dedicated previews for all upcoming central bank rate announcements.

Written by FP Markets Chief Market Analyst Aaron Hill