Stocks have retreated from record highs after a fresh US military strike on Iran and Kuwaiti reports of missile attacks dented investor confidence in a peace deal that many see as key to easing global inflation risks.
Oil rose as much as 4 per cent and bond prices tumbled as the escalation muddied signals on peace talks, after US President Donald Trump dismissed an Iranian report of a deal to resume traffic through the Strait of Hormuz.
"Over the next two weeks, we expect either a deal for a new ceasefire, or the current ceasefire will have collapsed with active hostilities resuming," said Madison Cartwright, a senior geo-economics analyst at CBA.
He put a 70 per cent probability on a deal,but said the fate of the strait remained uncertain.
"Insurance through the strait has become prohibitively expensive and it's unclear how and at what price insurance will be made available," he added.
"It is also not clear if Iran will charge a toll, or a toll by another name."
The US military said it had carried out new strikes targeting an Iranian drone operation, while Tehran said it had attacked a US airbase in Kuwait.
With transits through the strait still at a trickle, Brent crude was up 2.5 per cent at $96.6 a barrel.
The price has fallen back from four-year highs above $126 in late April, but remains 33 per cent above pre-war levels and 50 per cent higher than a year ago.
Yields on 10-year Treasury notes were up 1.7 basis points at 4.5 per cent, as sustained high oil prices kept upward pressure on inflation expectations. Euro zone yields also rose, with Germany's 10-year Bund up 1.5 bps at 3 per cent.
The developments also cooled this week's tech-led rally in stock markets that had pushed global indexes to new record highs.
Europe's STOXX 600 was down 0.6 per cent in morning trading, just below February's all-time peak, while US stock futures were down 0.1 per cent to 0.2 per cent.
Attention now turns to US personal consumption expenditures (PCE) data, which includes the Federal Reserve's preferred inflation measure.
Higher fuel costs are expected to lift the headline PCE to a three-year high of 3.8 per cent, while core inflation is seen rising 0.3 per cent to an annual 3.3 per cent, well above the Fed's 2 per cent target.
The pick-up has prompted more Fed policymakers to call for dropping its easing bias, or even preparing for a rate hike.
The shift in Fed expectations has supported the dollar, which held at 99.506 against a basket of currencies, steady on the week.
"I know there's an awful lot of dollar bears out there, and they have been for a while. But there's always a contrarian story here. And it could just be that the dollar has a bit of a resurgence now," Trade Nation market strategist David Morrison said.
The dollar hovered near a four-week high against the yen at 159.5, just below the 160 level that has previously triggered Japanese intervention.
The euro eased 0.1 per cent to $1.161 and is on track for a 1.1 per cent monthly fall, though expectations of a June European Central Bank rate hike offer some support.
ECB Chief Economist Philip Lanesaid on Thursday policymakers must prevent the jump in energy costs feeding into broader inflation expectations.
In commodities, gold slid 1.5 per cent to $4,390 an ounce, pressured by a stronger dollar and higher bond yields, which reduce its appeal as a safe haven.
