Talking Points

May 29, 2026 | 13:21

Schrödinger’s Deal

Economist

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter brings more than three decades of experience analyzing gl... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter brings more than three decades of experience analyzing gl... (Read more)

Deal or no deal? While we await the answer, markets have largely decided to move on from the conflict with Iran. In fact, some markets moved on the moment the President suggested the war was “nearly over” in late March. Oil prices peeled back to around $87 on Friday, posting the lowest weekly average price since the war’s first week. This helped further quell the fires in bond yields, clipping the 10-year Treasury more than 10 bps on the week and taking the 30-year back to just below 5%. Most currencies were about flat against the dollar, but equities seized on the combination of lower oil and lower yields to rally on. The S&P 500, Nasdaq, Dow and TSX all reached all-time highs in recent days, with some doing so for the first time in nearly three months. It appears that the old “sell in May” adage only worked for oil this year.

Even with the pullback in oil prices and the ongoing rally in equities, there are concerns about the lingering economic effects from the conflict. For starters, the one-year futures price for WTI barely budged this week and, at around $75, is still up about 20% from pre-war levels in the low-$60 range. That new higher price syncs well with our working assumption of an average oil price of $75-80/bbl for 2027 (versus an average of about $85 this year). But perhaps more fundamentally, there is the ongoing risk that the spike in oil will work its way into other prices, broadening out inflation. To this point, there is little evidence of these so-called second round effects—even the hawkish ECB allowed that signs of spillover inflation are sparse, so far.

The latest round of inflation data from the U.S., Europe, Japan, and even Australia suggested that inflation is mostly contained to energy. Some will debate that point, as the important U.S. core PCE price index rose 3.3% y/y in April, its highest since 2023. But that pick-up reflects strength earlier this year (i.e., before the war), and the latest monthly increase was a mild 0.2%. Moreover, Fed Chair Warsh is focusing on other measures of core, such as the Dallas Fed’s trimmed mean, which held steady in April at a moderate 2.3% y/y pace. Even if one doesn’t fully agree with the Chair that this measure is the best available, it’s also not far from core CPI (2.8%).

Moreover, if oil prices have truly peaked, even headline inflation should soon top out, and even go into slow reverse in the second half of the year. For example, gasoline prices have slipped about 3% below their May average in recent days (and 6% below in Canada), pointing to the very real possibility that energy could actually drag on inflation as early as the June results.

Beyond any lingering inflation issues, the spike in energy has tamped down growth in a wide variety of economies. The common theme in much of the world was modest activity in Q1, and it was only the last month of that quarter which was affected by the conflict. First-quarter GDP was revised down in the U.S. to a below-trend 1.6% pace (from 2.0%), even with the help of a reopening of the government after the shutdown held Q4 to just a 0.5% advance. The Euro Area cooled to just a 0.6% annualized pace in Q1, including an outright decline in France (-0.4%).

But it’s America’s two biggest trading partners—Mexico and Canada—that have really struggled to grow, amid the ongoing trade uncertainty and just as USMCA talks are gearing up (at least with Mexico). Mexico’s GDP fell in Q1, and has only managed to grow 0.4% y/y, versus a 15-year average growth rate of 1.5%.

Even more surprising was Friday’s revelation that Canadian GDP dipped 0.1% a.r. in Q1, versus consensus expectations of 1.5% growth. That big miss was compounded by the fact that GDP also fell in Q4 at a revised 1.0% annual rate (initially estimated at -0.6%), immediately triggering a wave of “technical recession” chatter. But note that the jobless rate has been steady over the past year (at 6.9% in April, precisely unchanged from a year ago), which hardly screams “recession”. Still, there’s no debate that both job growth and GDP growth have essentially been flat since the trade conflict with the U.S. erupted over a year ago.

We will freely admit that our estimate on Q1 GDP was a major swing-and-a-miss. But we will also point out that when the U.S. Administration’s threats of tariffs first emerged in a significant way early last year, we warned that such actions could tip the Canadian economy into a mild downturn, and even a technical recession. We assumed that the heaviest hit would land in Q2 of last year, and it was indeed a negative quarter as well. The surprise has been that the tariffs have not progressed in a smooth pattern; in fact, it’s been mostly chaotic, which may be part of the plan. But that has also meant that the economic impact has been more drawn out, if a bit less acute than we initially assumed. The point is that Canada’s GDP has dipped 0.1% in the year since the tariffs began, with notable declines in exports and business investment, pretty much matching our initial take on the trade war’s impact.

As a concluding note, it’s fascinating that the USMCA is coming into sharper focus at the very moment that the three participants are preparing to jointly host the World Cup (begins June 11). We will have a lot more to say on the topic, or at least its economic effects, in next week’s Focus. To be clear, we view the economics as very much a secondary or even tertiary story around the Cup. But our conclusion is that the tournament will deliver at least a small, albeit short-lived, bump to activity in the host nations. And given the extremely modest growth of both Canada and Mexico over the past year, even a small growth bump will be warmly welcomed at this stage.

Quick quiz: What is the antonym of “stagflation”? If oil prices keep receding, we may need to create such a word. A sustained pullback in oil will certainly help turn headline inflation around, but it could also set the conditions for a revival in growth, especially with an AI spending boom fully under way and robust equity markets underpinning household wealth. Japan and Germany are early adopters on this front. Both reported a dip in unemployment rates in the latest month, while also flagging a slight dip in headline inflation in May. While that trick might not be repeated by other major economies right away, it certainly sets an encouraging example.

Best answer: “Goldilocks”, but there really isn’t an official word for a situation of lower inflation and strengthening growth. One could simply call it a disinflationary expansion, and that may yet unfold in H2, if Schrödinger’s deal is in fact alive.