Macroeconomic Update: Growth Resilience Meets Geopolitical Risk

This Macroeconomic Outlook report is excerpted from the Second Quarter 2026 Fixed-Income Sector Views.

The U.S. economy entered 2026 on reasonably firm footing, with tailwinds from fiscal policy, AI investment, and relatively easy financial conditions. The labor market showed signs of stabilization to start the year, and disinflation looked poised to resume as tariff effects faded.

That narrative has been challenged with the war in Iran and the energy supply shock. Our base case remains that hostilities will ultimately be contained and relatively short-lived, allowing oil prices to trend down from above $100 per barrel to around $80 by year end. In that case, the economic impact should be manageable. This scenario would see a modest hit to growth, a large but temporary spike in headline inflation, and limited passthrough into core consumer prices.

The more concerning scenario involves a prolonged conflict that moves beyond disrupting energy transport and further damages production capacity. While we think it unlikely, in that case, crude prices could remain well above $100 per barrel for several months. The knock-on effects would be significant: a jump in headline inflation that spills over into core inflation, a squeeze on consumer purchasing power, disruptions to global supply chains, and amplification of the shock through tightening financial conditions and a softer labor market. The United States is better insulated than most other countries in this scenario, but it would lead to a meaningfully higher probability of recession.

For now, we expect the economic impacts of the war to be moderate. Real GDP growth in 2026 is expected to be around 2 percent, with tax cuts cushioning the hit to consumers from higher gas prices, and AI capital expenditure (capex) generating a sizable impulse to growth. The labor market remains a watchpoint. While unemployment has leveled off, hiring rates are historically subdued. This thin buffer means even a modest uptick in layoffs could mean a quick rise in the unemployment rate. An intensifying energy shock could be a catalyst for such layoffs, as could disruptive AI impacts.

Year-over-year core personal consumption expenditures inflation is expected to stay sticky this year, driven by hot first quarter readings and near-term impacts from oil passthrough. However, we expect sequential measures will show more disinflation in the second half as tariff and energy impacts fade. The jump in energy prices has generated volatility in expectations for Fed policy, amid conflicting risks to inflation and the labor market. The Fed will likely remain on hold for the next few meetings given the uncertain environment. However, in the second half, we expect fading inflation, along with risks to slower growth and a softer labor market, to ultimately influence Fed policy.  We continue to view two rate cuts beginning in the second half of 2026 as the most likely scenario.

—By Matt Bush and Maria Giraldo

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