Hormuz limbo lifts oil prices, fuelling inflation worriesBond yields jump across the board on firmer rate hike expectationsGold and stocks tumble but dollar climbs to 2½-week highPound leads FX losers amid twists and turns of UK politicsMarkets Reassess Inflation Risks as Hormuz Stays ShutRisk appetite has taken a knock as the week draws to a close, as markets undergo a reality check amid the ongoing stalemate with Iran. The renewed jitters come as US President Trump and Chinese President Xi wrap up their highly anticipated summit without any clear plan on how to end the blockade of the Strait of Hormuz.Although Iran was never the main objective of this summit, the market reaction suggests part of the complacency in downplaying the seriousness of the situation in the Middle East was due to investors holding out for some sort of intervention by China upon the request of the United States.However, whilst it seems China has agreed to use its influence over Iran to work towards the reopening of the crucial oil shipping lane, the absence of a timeline has started to worry investors. Moreover, President Trump continues to send mixed messages about America’s commitment to restoring oil and gas flows in the Strait of Hormuz.The issue of Iran’s nuclear program and what to do with its stockpile of uranium continues to be the main stumbling block in the stalled negotiations. China appears to support the importance of containing Tehran’s nuclear ambitions, but Trump may nevertheless be running out of patience with Iran.His comments to Fox News have raised concerns that the US is ready to resume its strikes on Iran if there’s no breakthrough soon.Oil Surge Pushes Up Rate Hike BetsOil prices are climbing again, with WTI and Brent futures up more than 3% today. More importantly, markets are taking note of the past week’s gains and continued impasse in the peace talks, with government bonds being sold off sharply.The 10-year US Treasury yield has jumped to a one-year high of 4.55% on Friday. Japanese and UK yields have also risen substantially as the two countries face higher debt risks at the moment than their peers.This week’s hot inflation data out of the US has likely exacerbated the panic, leading investors to price in additional tightening by the major central banks than they initially expected from the Middle East crisis.Investors now think there’s a 50% probability the Fed will hike in December while a 25-bps increase is fully priced in for the ECB and Bank of England by July.The renewed surge in yields is taking its toll on gold, pushing the precious metal back below $4,550.AI Rally: Just a Breather or a Correction?Unsurprisingly, equities are also plunging on Friday, with Wall Street futures joining the global slump. At this point, the drop in US stocks is more of a healthy pullback than a sign that the AI rally is coming to an end, especially as a breather is much needed before next week’s all-important results by Nvidia.Strong earnings in the AI sector, as well as more broadly, fuelled a seven-week rally in the S&P 500 and Nasdaq. As long as earnings expectations remain healthy, Wall Street can likely absorb one or two rate hikes by the Fed. The latest retail sales figures released yesterday showed that American consumers continued to spend in April despite higher gasoline prices.Not a Great Week for the Yen and PoundBut the picture is not as optimistic elsewhere as other countries face greater risks of stagflation. In Japan, worries about the impact of the energy crisis prevented the Bank of Japan from hiking rates in April, but a June hike now looks likely.Yet, the yen remains constantly under pressure, with authorities suspected to be intervening on a regular basis to slow down the dollar’s return to the 160-yen level. Against a basket of currencies, the dollar is at its highest since late April.The pound has had an even worse week, heading for losses of 2.2%. Political uncertainty has come back to haunt sterling, as Prime Minister Keir Starmer has gone from one blunder or crisis to another.Following last week’s disastrous performance of the Labour party in local and regional elections, Starmer has been unable to quell the growing calls for him to resign.His health minister, Wes Streeting, yesterday resigned from the cabinet but has yet to formally launch a leadership challenge. However, all eyes are now on Andy Burnham – the hugely popular Labour mayor of Manchester – who is seeking to rejoin parliament by becoming a candidate in the next byelection.The likely protracted period of an eventual leadership contest is likely to weigh on the pound for some time, while UK gilt yields could rally to fresh highs.