Economic Outlook

Growth

The advent of war in the Middle East has altered the character and scope of the risks facing the US economy in 2026. Oil prices are up more than 40% since the beginning of the conflict, gasoline prices are up about 30%, and diesel has increased even more—by roughly 50%. Although the US is a net exporter of petroleum products, a closure of the Strait of Hormuz would still disrupt global energy supplies, as roughly 20% of the world’s oil consumption transits the strait, and oil prices are set in global markets. The Persian Gulf is also a critical supplier of liquefied natural gas (LNG)— natural gas cooled to about -260°F so it can be shipped long distances—with Qatar alone accounting for about 20% of global LNG trade. In addition to its roles in heating and electricity generation, natural gas is an essential feedstock in the production of agricultural fertilizers and plastics. 

These new risks are occurring at a time when other, somewhat unrelated, risks are challenging many of the growth assumptions made by analysts at the beginning of 2026. Job formation, which had progressed at a strong pace from the end of COVID through most of 2024, has noticeably weakened. The US economy lost 92,000 jobs in February and has now lost jobs in four of the last six months. Credit concerns, which can be indicative of a turn in the economic cycle, have recently come to the fore with defaults by multiple users of private credit. Some private credit funds have recently altered or curtailed redemptions because of liquidity constraints in the private credit markets. High yield credit spreads have widened 0.6% since midJanuary. Credit issues may remain contained in the more opaque world of private credit, however, many commercial banks also have indirect exposure due to loans they have extended to business development companies and private credit pools. Private credit is assumed to house greater credit risk than bank loans because it is less tightly regulated. It is also less transparent. Once credit issues appear in the economy, it is not uncommon to see them multiply. In this case, contagion could come from banks that have extended credit to providers of private capital. Finally, progress on inflation, which had improved fairly steadily since hitting 9% in the summer of 2022, has now stalled. Some measures of inflation are presently moving up—higher energy costs and tariffs won’t help.

So far, the US consumer, the primary engine of US economic growth, is holding up surprisingly well. Personal consumption expenditures were up 2% in the fourth quarter of 2025, and that pace appears to have carried over into January of this year. Much of the growth in spending came from necessities such as healthcare and utilities. Discretionary spending is showing some signs of strain. 

US Real GDP expanded at a lackluster pace of 0.7% in the final quarter of last year, based on the second estimate. Those results were clearly impacted by a protracted government shutdown. For the most part, government outlays are brought forward once a shutdown ends, so we may see an offsetting improvement in GDP in the first quarter of this year. We will also see some effects from the fiscal stimulus of the One Big Beautiful Bill Act. Together, those may offset some of the negative pressures from war, energy prices, inflation, and a loss of momentum in job formation. A great deal turns on the duration of the war with Iran. The longer oil stays above $100 per barrel, the greater the contribution to inflation and potential damage to growth. The loss of LNG supplied from the Persian Gulf will soon start to impact the price and availability of fertilizer and therefore the cost of food. Energy, especially diesel fuel, and fertilizer are two key components in food prices. With job formation at cycle lows, it would not take too big a hit to the drivers of growth to see the US tip into recession.

Employment

• US payrolls shrank by 92,000 in February 
• Job growth has averaged below 30K for the last four months 
• Unemployment ticked up to 4.4%

The US economy lost 92,000 jobs in February and has now lost jobs in four of the last six months. Unemployment rose only slightly to 4.4%. Job openings increased to 6.9 million in January but have declined 6.5% over the past year. There are now 0.6 openings for each unemployed person. The number of job openings and unemployed persons were roughly equal as recently as June of last year. The quit rate held at just 2%, indicating that employees are holding on to their jobs. The quit rate typically rises when workers are confident they can find a better job. The low job formation and low quit rate have been labeled the “no fire, no hire” economy. 

Many employers seem reticent to add to payrolls, anticipating the potential impact of artificial intelligence on the future need for certain types of workers. Although it does not appear that AI is presently having a strong impact on US worker productivity, many employers are basing staffing decisions in part on the assumption that AI will have an impact on job demand in the future. 

The employment situation was the most important factor in the Fed’s decision to cut rates three times last year and will continue to provide an argument to cut rates again later this year. For now, however, the Fed must balance that concern against the threat of stubbornly high inflation.

Inflation

• Inflation stuck at 2.4%–2.5% 
•  February headline CPI was 2.4% 
• Core CPI was 2.5% •
• Tariffs and energy make improvement challenging
   

Headline CPI came in at 2.4% in February and the month-over-month reading came in a little higher than recent averages. “Core” inflation (excl. food and energy) was up 2.5%. Inflation had been gradually improving since the summer of 2022 but now appears stuck above the Fed’s stated goal of 2%. The February numbers do not yet reflect any impact from the spike in energy costs that accompanied the onset of war in the Middle East. It is estimated that if energy costs remain where they are for an extended time, those costs could add another 0.3% to the rate of inflation, per the most recent Fed inflation forecast. The Producer Price Index (PPI) for final demand came in at 3.4% in February, the highest reading in 12 months. The PPI is especially concerning since it tends to be a leading indicator of consumer price inflation. 

Weakness in the labor market could help put a damper on inflation since weakness in job formation tends to slow down wage inflation. Wage inflation is one element of overall inflation, but it would be an important component to any sustained inflationary cycle.

Interest Rates

• The Federal Reserve held overnight rates steady at its March meeting 
• Short-term target rate holds at 3.50%–3.75% 
• Key 10-year Treasury rate moves up to 4.40% on inflation concerns

The Federal Reserve’s Open Market Committee met on March 17 and 18 and held its target for short-term interest rates at 3.50–3.75%. This was the action expected by the markets. At his press conference following the meeting, Chair Powell indicated that the US economy was still expanding at a “solid pace” but allowed that housing was weak and job formation slow. He acknowledged that inflation would likely rise due to the sharp increase in the price of oil but also indicated that a crucial factor was the duration of the increase. He emphasized that the duration of the war and the period of elevated energy prices was a true unknown in the Fed’s economic outlook. He further expressed that, overall, the US economy was doing “pretty well.” He noted that because the US is a net exporter of oil-related products, higher oil prices could be offset in part by stronger export revenues. However, he also acknowledged that the overall impact of the price spike would likely place downward pressure on spending and growth while pushing inflation higher. 

The key yield on the 10-year Treasury note has moved up to 4.40% from a level just over 4% prior to the start of the war. This move reflects bond traders’ views that inflation will be a greater challenge in the future. The 10-year Treasury rate is a key benchmark rate for setting interest rates on credits such as mortgages. The national average mortgage rate has moved from 5.98% to 6.22% during the first two weeks of March. More surprisingly, shorter rates, such as the yield on the 2-year Treasury note, have also moved up from 3.42% to 3.68% since the advent of the war. This move is more surprising because the overnight rate (so recently left unchanged by the Fed) has a much greater influence over shorter-term interest rates. The market appears to be adjusting to the possibility that the Fed may be forced to raise rates if inflation rises with energy prices. The Fed will have a new chair beginning in May of this year (assuming he is confirmed), and the expectation is that the designated chair, Kevin Warsh, will be an advocate for lower rates.

Markets

• Stocks sold off sharply on news of war 
• Risk assets remain under pressure •
• Credit spreads have widened 
• Gold and oil diverge

US equity markets have endured their most turbulent stretch since the April 2025 tariff shock. The S&P 500 peaked at a record 7,002 on January 28 before the onset of war in the Middle East erased this year’s gains and more, closing as low as 6,474 on March 20—a drawdown of roughly 7.5% from the pre-war peak—before partially recovering to near 6,581 by March 23. The selloff has been broad-based, but particularly painful in large-cap technology, where elevated valuations left little room for the kind of uncertainty the market is now pricing in. What has been notable, however, is that the damage has not been catastrophic relative to the severity of the geopolitical event—a reflection of still-resilient corporate fundamentals and investors’ learned tendency to buy dips after prior shocks. The key question now is whether an escalation or a sustained Hormuz closure would force a more significant repricing of earnings and growth expectations. With forward earnings for the S&P 500 estimated at around $320 per share and the forward P/E ratio compressing to approximately 20x from a stretched 25x at year-end, valuations are meaningfully more reasonable than they were entering 2026, which provides a more constructive starting point for investors with a longer time horizon.

Credit markets have shown strain but remain orderly. The ICE BofA High Yield Option-Adjusted Spread widened to 3.2% as of March 23, up modestly from earlieryear tights, as investors grow more cautious about the growth and refinancing outlook for lower-quality issuers. For investment-grade credit, all-in yields near 5% continue to attract strong demand from both domestic and global buyers, limiting the degree of spread widening—a dynamic that has historically anchored the investmentgrade market even during periods of equity volatility. High-yield bears are watching more closely: a slower growth environment, combined with higher-for-longer rates and elevated leverage from the 2021–2023 issuance boom, creates a more challenging refinancing backdrop for the back half of 2026. West Texas Intermediate (the US crude benchmark) has surged sharply since the outbreak of the Iran conflict, with prices recently spiking as high as $113 per barrel before settling back into the $92 range. Rising oil prices have become a dominant macro driver, especially with the US Strategic Petroleum Reserve (SPR) still far below its historical capacity at roughly 415 million barrels, following the large 180-million-barrel release that began in May 2022 to contain fuel prices after Russia’s invasion of Ukraine. This leaves the US more exposed to future oil price shocks and threatens to pass through to headline CPI, further complicating the Fed’s path.

Gold, after briefly surpassing $5,300 per ounce during the peak fear episode in early March, has pulled back to approximately $4,400 per ounce at the time of this writing due to rising yields, a strengthening dollar, and profit-taking. However, it still remains more than 40% above year-ago levels, reflecting how durably markets are pricing in inflation uncertainty and geopolitical instability.

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