Conflicting Signals: No Worries or Brace for Impact?

Financial markets have been partying like it’s 1999 to borrow a phrase from the artist formerly known as Prince. Hints of a U.S.-Iran ceasefire extension, a new Israel/Lebanon ceasefire, and FOMO unexpectedly brought equities to new record highs this week, extended by Friday’s opening of the Strait of Hormuz by Iran. The S&P 500 hit a new high above 7,100—up about 43% from the post-tariff low set just over a year ago (Chart 1). The S&P Volatility Index (VIX) fell below pre-war levels to 17, creating an eerie sense of calm. Investors cheered the near $30 drop in WTI crude oil futures from last week’s high and scaled back expectations of a prolonged inflation shock. The 2-year Treasury market inflation break-even plunged more than 40 bps from a mid-March peak, and we saw notable improvement in the 5-yr break-even too (Chart 2)—all welcome trends.

So, is the oil shock over? I would like to put on rose-colored glasses and believe all is well, but the situation could still go off the rails. Meanwhile, whiffs of economic and inflation trouble are already surfacing, and it’s still early days. Let’s review a few developments this week that lead me to believe this energy price shock may have a longer tail than investors currently believe.

First, damage to Gulf energy infrastructure is clearly evident. Reuters has reported dozens of facilities hit across Saudi Arabia, UAE, Kuwait, Bahrain, and Qatar in at least 30 to 40 confirmed attacks. Investors may still be underestimating the extent of the physical disruption that has occurred to the global oil market, which could linger into Q3 and beyond. Notably the spot price for Brent crude, at over $116/barrel (as of April 16), has not been as well behaved as the active month futures contract. IEA’s April Oil Market Report, released on Tuesday, called the attacks on regional energy infrastructure and ongoing restrictions in the Strait the largest disruption of global oil supply in history.

The heads of the IEA, IMF, and World Bank met this week and issued this statement: “…the impact of the war is substantial, global, and highly asymmetric, disproportionately affecting energy importers, in particular low-income countries. The shock has led to higher oil, gas and fertilizer prices, triggering concerns about food security and job losses as well. It will take time for global supplies of key commodities to move back towards their pre-conflict levels—and fuel and fertilizer prices may remain high for a prolonged period given the damage to infrastructure.” Then, the IMF trimmed its global growth forecast for 2026 to 3.1%, and created more adverse and severe scenarios for the path of oil prices that sent global growth as low as 2.6% and 2.0%, respectively, this year.

In the U.S., the fingerprints of higher inflation and damage to the consumer are already visible. The University of Michigan Consumer Sentiment index sank to an all-time low in April (Chart 3). The NAHB’s homebuilder survey plummeted to its lowest level in seven months, cutting short what many thought would be a recovery year for home sales and construction. The ISM revealed a nearly 8-point increase in prices paid in March alone, in both manufacturing and services sectors (Chart 4). Need more evidence? The March PPI showed alarming increases in energy, finished goods, transportation, and warehousing prices. Another wave of inflation has begun; where it stops, no one knows.

Fed Heads: The Plot Thickens

This week (April 14), the Senate Banking Committee announced it will hold a hearing on Kevin Warsh’s nomination to be Chair of the Fed’s Board of Governors on April 21. The nomination was first announced by the President on January 30 and officially forwarded to the Senate on March 4. Part of the delay in scheduling the hearing reflected the effort to address a potential impasse in approving the nomination (and sending it to the full Senate for a vote), despite the Republicans having a 13-to-11 majority in the Committee.

Republican Senator Tillis (who is resigning when his term ends on January 3, 2027) has said repeatedly that he will not vote to approve the nomination (despite favoring Warsh) as long as the Department of Justice (DoJ) is investigating Chair Powell over his congressional testimony on renovation costs at the Fed’s headquarters. As part of the investigation, grand jury subpoenas threatening criminal indictment were served on January 9. Powell responded: “The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the President.” The Fed took legal action.

On March 13, a federal judge quashed the subpoenas stating that a “mountain of evidence suggests that the Government served these subpoenas on the Board to pressure its Chair into voting for lower interest rates or resigning.” And that justifications for the subpoenas “are so thin and unsubstantiated that the Court can only conclude that they are pretextual.” The Administration requested reconsideration of the ruling on legal grounds, but the judge upheld the original decision (on April 3). Although the Administration said it would appeal to a higher court, it was thought that the quashing could allow the investigation to quietly end, thus removing a hurdle to Warsh’s approval.

However, this week (on the same day as Warsh’s hearing was announced), the DoJ upped the investigation ante. Two prosecutors and a criminal investigator arrived unannounced at the Fed’s HQ requesting a tour. They were denied. Senator Tillis dug in his heels (on April 15): “They can escalate for the next 263 days. My position is not going to change until their posture changes.”

The hearing will go ahead as scheduled, and we figure the questioning will get testy at times, particularly on the topic of Fed independence. But at this point, it does not look like the nomination will be able to garner a majority of votes with Senator Tillis siding with the Democrats (so 12-12). This increases the odds of Warsh not being confirmed by May 15, when Powell’s term as Fed Chair ends. In the event, Powell has stated: “If my successor is not confirmed by the end of my term as Chair, I would serve as Chair pro tem until he is confirmed. That is what the law calls for, that’s what we’ve done on several occasions—including involving me—and that’s what we’re going to do in this situation.” This would be the sixth time this has occurred.

This week, in a Fox Business interview aired the morning of April 15, President Trump said he would not drop the investigation; and, if Powell was still the Fed Chair after May 15… “Well then I’ll have to fire him, OK?” It is unclear what the grounds for dismissal would be.

Meanwhile, the Supreme Court has yet to rule on whether the President has the power to fire Governor Lisa Cook over her mortgage dealings. Verbal arguments were heard on January 21 and the judges reportedly sounded skeptical concerning the merits of the case. A decision is expected by June.

Once Warsh takes the Chair’s chair, now-Governor Powell (whose term runs until January 31, 2028) would typically be expected to resign. However, Powell has said, “I have no intention of leaving the Board until the investigation is well and truly over, with transparency and finality.” We suspect he would also want to wait around for the SCOTUS ruling on the Cook case.

And there is another potential twist. But first some facts: All (seven) Fed governors are appointed by the President and confirmed by the Senate, with the Chair and Vice Chairs further appointed by the President from among the governors and confirmed again by the Senate. The Board of Governors approves the presidents of the 12 Federal Reserve (regional) banks. Together, these 19 folks make up the Federal Open Market Committee (FOMC), among which a group of 12 vote on monetary policy (all seven governors, the President of the New York Fed, and an annual rotation of four other regional Fed presidents).

So, here is the rub: By statute, FOMC participants decide amongst themselves who will be the Chair and Vice Chair of the Committee. By convention (and not statute), the Committee picks the Fed Chair as FOMC Chair and the New York Fed President as FOMC Vice Chair. One can imagine a scenario in which Warsh, on becoming Fed Chair, is causing immediate concerns about Fed independence and credibility. Should Governor Powell still be around (waiting for the investigation to be resolved and Lisa Cook’s fate to be decided), imagine if he was temporarily tapped to remain as FOMC Chair? It is a low probability scenario, but the Administration would not be amused.

U.S. Commercial Real Estate Market Update

Multifamily residential could remain the soft spot in commercial property markets this year due to weak population growth.

Highlights:

• Demand for industrial space remains well-supported by a pickup in manufacturing output and data center construction, and the sector continues to enjoy the lowest default rates in the CRE space.

• Apartment leasing demand remained healthy last year as homeownership is still expensive, though immigration cuts and weak job growth could keep vacancies elevated and rents under pressure in 2026.

• The retail sector is seeing low vacancies and rising returns, but has softened amid a slowdown in spending and employment, a trend that could continue this year if energy prices remain high.

• With more companies requiring in-person work, the office segment is returning to life, though progress has been uneven across regions and asset classes. Despite weak employment growth, vacancies are easing from elevated levels, with most of the improvement in higher-quality buildings. Further progress is expected this year.

• Multifamily residential could remain the soft spot in commercial property markets this year due to weak population growth, while tariffs and the Iran war pose downside risks to all segments.

Industrial

Demand for industrial space accelerated in 2025 amid a pickup in manufacturing and strong demand for data centers. Net absorption jumped 16.3% in the year (Cushman & Wakefield), helping to stabilize vacancy rates at 7.1% in 2025Q4, near historical norms. At the same time, the earlier construction boom in manufacturing facilities has reversed direction. Still, growth in industrial asking rents slowed to 1.5% y/y in 2025Q4, the lowest rate since the pandemic. Despite this, and a modest decline in industrial property values (CoStar), total returns (net operating income plus the change in market value) held steady at just over 1% in 2025 (Chart 1). The 30-day delinquency rate on commercial mortgage-backed securities (Trepp) stayed low at 0.65% in March 2026, little changed from a year ago. Continued economic growth should hold delinquencies down in 2026, despite higher energy costs.

Multifamily Residential

Despite little growth in the population or employment, apartment demand was healthy in 2025. High ownership costs continue to push new households into the rental market while keeping existing renters in place longer. Last year, net absorption of apartment rental space was the third-strongest in the past quarter-century (Cushman & Wakefield). However, new rental supply remains elevated, keeping the apartment vacancy rate at a record high of 9.3% at year-end and slowing national asking rent growth to just 1.1% y/y last year. Rent concessions are common, notably in the South, which overbuilt apartments in recent years. As a result, the median rent on new apartment leases fell 1.7% y/y in March 2026 (Apartment List). Still, total returns on multifamily properties were modestly positive at just over 1% last year, helped by a 1.3% y/y rise in property values in 2025Q4. Nonetheless, the 30-day CMBS delinquency rate rose sharply to a near-decade high of 7.2% in March 2026, as owners wrestle with still-elevated borrowing costs. With immigration curbs continuing, 2026 could mark another year of elevated apartment vacancy rates and slower rent growth, straining the finances of some landlords.

Retail

Though softening, the retail sector is in decent shape. Net absorption turned negative last year (Cushman & Wakefield) as real consumer spending slowed, albeit to a still-healthy rate of 2.6%. Rising equity values supported spending of upper-income households, but slower wage growth restrained demand by lower-income earners. Even so, retail vacancy rates stayed relatively low at 5.7% in 2025Q4, with little new supply reaching the market, while asking rents continued to rise modestly. At 1.6% in 2024Q4, total returns on retail properties were the highest among the four major commercial property segments, helped by a 0.7% y/y increase in values. Some mall owners are finding success by appealing to younger shoppers craving more social interaction. Nonetheless, digital sales continue to rise, accounting for a record 16.6% of total retail sales in 2025Q4, compared with just 6.9% in Canada (Chart 2). The growing use of AI shopping agents could push online sales even higher. The 30-day CMBS delinquency rate on retail properties fell sharply to 6.6% in March, with further modest declines likely this year. While pricier gasoline could slow consumer spending to a 1.8% rate in 2026, personal income tax cuts should help cushion the blow.

Office

The office market is on the mend. Demand picked up in 2025, notably for Class A space, as net absorption increased after three years of declines. Return-to-office rates continue to rise, though remain well below pre-pandemic levels at around 55% in early April, according to Kastle’s occupancy measure for ten cities (75% for Class A+ buildings). The national office vacancy rate edged higher to 20.5% in 2025Q4 (Cushman & Wakefield), but appears to be stabilizing amid the lowest addition of new office space since 2012 and falling sublease space. Surprisingly, office property values jumped 5.5% y/y in 2025Q4 (CoStar), the most among major CRE segments, albeit following a brutal 43% drop in the previous three years. The upturn in values helped total returns turn positive, though they remain the lowest among CRE segments at just 0.8% in 2025Q4. After reaching record highs (dating back to 2000) of 12.3% in January, the 30-day CMBS delinquency rate for office buildings pulled back to 11.7% in March. Some further modest improvement is expected in 2026. Investors are trickling back to the sector, attracted by deep discounts on some buildings and a sense that the worst is over. Vacancy rates are expected to decline in 2026 amid little new construction and ongoing conversions to residential units. The main risk to the office segment stems from possible persistent weakness in employment due to immigration cuts and restructuring. Amazon recently announced plans to slash its global office footprint to reduce its average office vacancy rate from about 31% to under 23% in 2026.

AI and Office Space

AI will gradually reshape office demand, replacing workers in some industries while creating new jobs in others. It will displace workers in routine, knowledge-based positions, while shifting others into higher-value work (e.g., from back-office roles to sales). Although some occupations, such as coding, data entry, research assistance, and customer service, are more vulnerable than others, there is limited evidence of widespread displacement, aside from some reduction in entry-level hiring. This is because, while AI can automate some formulaic tasks, it cannot replace entire positions that involve many different activities. Still, while AI will not eliminate the need for office space, it could reduce demand. The main reason businesses adopt it is to raise productivity. In addition, to the extent that AI improves coordination and collaboration, it may allow workers to spend less time in the office.

AI will likely increase the current bifurcation in the office market, putting a premium on newer, high-quality, state-of-the art buildings that are well suited for collaboration and computation. Lower-quality buildings could struggle unless landlords invest heavily in upgrades to amenities and the electrical system. Geographically, offices in major cities with deep pools of AI talent may benefit more than buildings in smaller centres.

All told, AI could slow growth in office demand, particularly for lower-quality buildings in secondary markets, though most current office workers are likely safe, for now.