In just five trading sessions, markets went from debating Fed cuts to preparing for possible rate hikes in 2027. Behind that shift: exploding war costs, a 6.0% PPI shock, and a dollar that refuses to weaken.
In this article, we discuss the impact of Middle East tensions on markets, how defense spending affects the economy, why the Fed may not cut rates in 2026, why the dollar is strengthening again, Key DXY levels to monitor, and why gold is falling despite inflation.
Pentagon Raised Warning of Increased War Costs
According to the Pentagon's testimony to Congress, the ongoing Operation Epic Fury has already cost American taxpayers $29 billion so far this year. In other words, the cost of the US-Iran conflict increased by $4 billion in just two weeks' time. Pentagon's acting comptroller Jay Hurst says that roughly $24 billion of those expenses were needed to repair and replace the equipment destroyed by the war. "But we have a lot of unknowns there," says Hurst, referring to expenses for repairs at US military bases damaged in the fighting.
How does the Iran war affect the US dollar? Fiscal impacts from such a large-scale conflict are not to be ignored, especially when the Department of Defense is now trying to push for an extra $1.5 trillion for the US defense budget 2027. At the same time, Republican congressman and head of the House defense subcommittee Ken Calvert asked whether the operation would have a negative impact on US military readiness over the long term.
These concerns show the first signs of a hawkish shift in fiscal policy among fellow Republicans who stand alongside the White House. In other words, war spending will lead to widening budget deficits and a growing supply of US government bonds, causing further crowding-out effects for private investment.
In addition to fiscal impacts, there is an even faster one that is likely to come through the channel of energy.
How is the Iran War Impacting US Inflation and Fed Decisions?
April CPI came in at 3.8% y-o-y, which is the highest figure since May 2023 and above the consensus forecast of 3.7%. Meanwhile, the rise in energy costs was as high as 17.9% y-o-y, while gasoline prices increased by 28.4% y-o-y, and fuel oil prices by 54.3% y-o-y. What is especially concerning to investors: core CPI, excluding food and energy, jumped 0.4% m-o-m and 2.8% y-o-y, above expectations.
But that was nothing compared to today's print. The latest PPI reading stood at 6.0% y-o-y and crushed the consensus estimate of 4.9%. Month-over-month change in producer prices also skyrocketed, reaching 1.4% and almost three times exceeding the anticipated 0.5% increase. What does it mean? If producer prices continue to grow at such a fast pace, the inflationary pressure in the consumer sector remains intact as well. Excluding food, energy, and trade, core PPI increased by 0.6% m-o-m and 4.4% y-o-y. Read our latest analysis to learn more about oil war’s impact on food prices.
Now to answer the question; Will the Fed cut rates in 2026? It doesn't really require deep expertise in economics to realize that this data kills the whole idea of rate cuts in H2 2026. Bank of America recently moved its projections for the first rate cut to H2 2027. According to the CME FedWatch index, currently, zero chances are seen for rate cuts in 2026, while 70+ percent probability stands for a rate hike in April 2027. In terms of interest rates, this represents an enormous repricing over just five trading sessions.
Image Source: CME FedWatchTool
Bond Market Update
As for the impact on treasury markets, bond yields have soared after the latest release. 2-year yield rose above 4%, whereas 10-year yield climbed to the highest level in ten months at 4.48%.
Dollar Index Technical Analysis (DXY)
The USD Index is currently sitting at 98.60 as a support for the safe haven amid an inflation surprise and rising tensions in the Middle East.
• Structural Ceiling: It goes without saying that the 2026 high at 99.18 (achieved back in April 8 on the failed ceasefire attempt) serves as the structural ceiling.
• Structural Floor: 97.60-97.80 stands as the established floor in this case. A breakdown below 97.60 on the confirmed close would lead to a retest of 97.00, followed by a Cambridge 90-96 year-end target.
Image Source: Trading View
At the moment, the dollar is being pulled towards 98.60 due to the CPI/PPI surprises and growing pessimism about the possibility of achieving peace in Iran. Once the reflationary effects are exhausted, the structural factors of dollar bearishness would return – including fiscal expansion, Fed hawkishness constrained by a supply shock, and a war that increases both oil prices and weakens consumer demand. The bias above 98.20 remains negative in my view until the dollar closes above 98.60 on the daily timeframe.
How the Dollar Drives Other Financial Markets
Once you understand the situation around the USD Index, the outlook of the best assets during inflation and war becomes obvious:
1. Crude Oil: It is hovering around $101 per barrel (WTI) and $103.8 per barrel (Brent). A peace agreement between Washington and Tehran would be bullish for oil and bearish for the dollar. As the IEA warns, global oil reserves "are rapidly shrinking," which should create a near-term floor for Brent. To track the US-Iran war's effect on oil prices, be on the watch for the test of the $100 level, which would indicate that peace negotiations are moving ahead.
2. Gold: After the inflation data was released, gold suffered a sharp sell-off with a test of the support near $4,600. Why is gold falling if inflation is rising? Well, gold is mostly priced by real yields. When inflation rises and the Federal Reserve prepares for more rate hikes, real yields become extremely attractive. Gold waits for the Fed to blink.
3. Silver: Opened at $86.36, it went as high as $88.3 by mid-day (2.23% daily gain). The silver price rally has continued for seven days in a row (from $72 to $88.3 in just seven trading days). But silver is the precious metal that reacts quickly to any dovish signals from Washington or Beijing, because at the moment, the gold/silver ratio stands at 53:1.
4. EUR/USD: The euro-dollar pair is hovering near 1.1710 as the dollar strengthens against it. EUR/USD is a direct beneficiary of the peace talks. By H2 2026, according to Cambridge's forecasts, the pair is expected to reach 1.18-1.23, but this will only happen once the Strait of Hormuz opens again.
5. US Stocks: Yesterday, the Nasdaq fell 0.87%, and the S&P 500 dropped 0.67% amid stock market inflation fears. S&P 500 futures struggle to recover from a loss caused by 1.4% MoM PPI print. Defensives outperformed, semiconductors underperformed.
What’s Next?
The Trump-Xi summit will take place in Beijing today through Friday. The Iran issue will be discussed during the talks, although Trump himself says that the main topic will be trade relations. The market expects a clear sign that Beijing favors peace talks – a general statement that the conversations were productive would have little impact, while a promise to address the issue in more detail would be a game-changer.
• Today's 6.0% print has killed the chance of rate cuts for good. If the dollar cannot break 99.18, it would mean that the bull run has finished.
• The Handover: Janet Yellen will hand the keys to the new Fed Chair, Jerome Warsh, on Friday. His first public appearance in that role will attract the attention of each and every fixed-income trader in the world.
The dollar isn't going anywhere anytime soon – and it's waiting for the hawkish chair to give some reaction to 6.0% inflation rate. There is nothing much that can be done right now, but knowing the levels and triggers.
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