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April 02, 2026 | 14:48
Economic Resilience Meets Inflation Headwinds
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economic Resilience Meets Inflation Headwinds |
| Economic resilience continues to impress. The economic indicators released so far for March point to an expansion that continued at a moderate pace despite rising gas prices and growing economic and inflation uncertainty from the war with Iran and the closure of the Strait of Hormuz. If growth is to survive this bout of rising inflation, it will need to be built on a foundation of continued labor market balance and enough consumers spending through the rise in prices. So far, the outlook appears manageable. Consumer confidence unexpectedly improved in March, rising a bit to 91.8 from 91.0 in February and a January low of 89.0. The entire gain was driven by a solid 4.6-point rise in the present situation index, even as future expectations held up (by slipping only 1.7 points). |
| This may be due to a largely stable and balanced labor market. The percentage of consumers who saw jobs as 'plentiful' versus 'hard-to-get' improved to 5.8% from 5.7% in February (Chart 1). Initial jobless claims for the last week in March sank to a meager 202k, their lowest reading in nearly three months with the 4-week average dropping to a modest 208k. ADP reported a steady 62k net private sector jobs were created in March, easily beating the consensus forecast. The February JOLTs data confirm this balanced message. Even as new hires fell 7.4% below year ago levels in February, layoffs fell an even steeper 7.8%. Unless layoffs accelerate significantly in the weeks ahead, labor market slack doesn’t appear to be a major problem. Higher percentages of consumers also saw business conditions as good in March and were looking to buy a motor vehicle or major appliance—not a sign consumers are yet seriously contemplating closing their wallets. Inflation-adjusted retail sales jumped at a robust 4.1% annualized pace in February with strong increases coming from most categories including health and personal care, apparel, sporting goods, and autos. Still, the headwinds from rapidly rising prices are coming into view and downside risks to consumer spending and labor market forecasts remain front and center. The ISM Manufacturing Prices Paid Index jumped to its highest level since June 2022 last month, rising a hefty 20 points since January. A broad futures commodity price index has surged 41.3% since April last year and is now back above its June 2022 peak (Chart 2). Average retail gasoline prices increased 26% in March, a bigger monthly price shock than anything seen during the pandemic or Ukraine war disruptions. Our best case oil price scenarios are already in the dustbin, leaving fewer avenues for a rapid end to this energy price shock. This week, we lifted our baseline forecasts for average WTI oil prices for 2026 by more than 13% to $85 from $75 and see oil hovering just below $98/barrel for all of Q2. We expect this to lift headline CPI inflation to nearly 4.0% year-on-year in the second quarter before gradually moderating to around 3.4% by Q4 (Chart 3). Next week, we get our first peek at the impacts of the energy price shock on CPI for March. We are bracing for a slightly above-consensus 1.0% increase in the headline CPI for the month and a 0.4% rise in the core measure, lifting the year-on-year inflation rates to 3.4% and 2.7%, respectively. That would already put the yearly headline rate a full percentage point above February’s pace with the core CPI increasing by a more modest two-tenths. If the Strait of Hormuz doesn’t open soon or if more energy infrastructure is damaged, I’m afraid this won’t be the last time we revisit our inflation forecasts. |
Can the Profit Machine Keep Humming? |
| Corporate profits have shown remarkable strength and consistency despite high uncertainty and changing macroeconomic factors. The conflict in Iran and oil price shock is yet another factor that threatens the profit machine heading into the Q1 earnings season. But this machine has been running strong, so it’s going to take something serious and sustained to break it down. Let’s have a look: Corporate profit growth on a national accounts basis was running near double digits heading into the end of 2025, with profits holding steady around record levels as a share of GDP. For the S&P 500, earnings growth was 14% for calendar 2025, and expectations for 2026 have held firm in recent weeks, although it’s early—they’re pegged at 18%. Growth is led by technology (+43%), but double-digit gains are also expected across energy, financials, industrials, communication services and utilities. At the macro level, there are a few things pushing and pulling on earnings as we look through the rest of 2026. Growth is pegged at a solid 2.3% a.r. in 2026Q1, but we expect higher oil prices will dull growth to below 2% through Q2 and Q3. Final private domestic demand has been rock solid on the back of business investment and consumer spending, and we suspect the former will hold up well while the latter will ebb. There are two offsetting positives. One is that the economy is less energy-intensive today than during past oil price shocks. At roughly 20 million bpd of consumption, that’s less than 0.7 barrels to produce $1,000 of real GDP (in 2025 dollars). That compares to around 1 barrel 20 years ago; and more than 2 barrels during the 1970s shocks. The second is that we are in the midst of a productivity boom, partly on the back of AI, driving real output per hour and dulling growth in unit labor costs. Energy prices do still matter, and they threaten to weigh on discretionary spending heading into the spring. Let’s just say that $4 per gallon would start to grate on consumer confidence if persisting into Memorial Day, and inflation moving back to near 4% in short order will weigh on real disposable income growth. The job market, wages and the household balance sheet are sturdy enough to provide offsets, but don’t be surprised if energy prices feature widely in earnings commentary. Talk of margin pressure has already started to pop up in areas like industrials and consumer staples. Meantime, higher Treasury yields have steepened the yield curve again, with the 10-yr/3-mo. spread just off the widest level since 2022. A steeper curve traditionally indicates stronger earnings growth, either directly through improved bank margins, or as a signal of economic strength. In this case, we’d dampen the signal given that higher longer-term yields have been driven by inflation expectations, at least in the front few years; and the bigger story, for equities, is that the Fed has been effectively priced out of rate cuts for 2026. The swing from falling to rising inflation, and from easing to not, is a big reason why equity valuations have compressed. A weaker U.S. dollar supports domestic earnings through higher export demand and the conversion of foreign profits back into local currency. Interestingly, the flight to safety has put some strength back into the U.S. dollar over the past month, reversing some of the weakening seen coming into to 2026. We’ll call this a wash for now. The Bottom Line: The U.S. profit machine is running strong enough to handle an oil price shock if the duration is contained. But this is still not good news at the margin. |
Updating Our Oil ForecastWe have updated our 2026 WTI forecast to reflect the fact the war has evolved somewhat differently than we had anticipated after it initially broke out. |
| As the Iran war drags on, the energy forecasting community along with an array of political/military experts have been forced to (significantly) reevaluate their views/predictions. Notably, the conflict has already surpassed most expectations that it would likely be quite short, similar in duration to last June’s 12-Day War, though the more surprising developments revolve around Tehran’s ability to effectively close the Strait of Hormuz (with relative ease) and inflict damage on regional oil and gas infrastructure. Complicating matters is the increasing uncertainty over what the post-war environment could look like as the U.S. Administration has been signaling that it could wind up military operations soon. For example: will the Strait return to its pre-war state, or could it end up being controlled by Iran or subject to constant/periodic disruptions? Put another way, there are a number of vastly different scenarios that could unfold over the short- and longer-term. New WTI AssumptionTo help cope with this uncertainty, we decided from the start of the conflict to take a weighted average of possible scenarios (benign to extreme), rather than focus on a most likely potential outcome, to help formulate our forecast for the price of West Texas Intermediate (WTI) crude. This strategy appears to have served us reasonably well so far with WTI’s average of |
| What about Brent?One might wonder what this means for the price of Brent crude or its differential/premium against WTI (Chart 1). The latter has surged since the war broke out (averaging > Balance of RisksDespite the revision to our WTI forecast, we still think that the balance of risks to this projection is tilted to the upside. This is because we simply can’t rule out the prospect of a further escalation of the conflict. This is despite the widely-held belief that the U.S. Administration would like to wrap up the war as soon as possible so that it can focus on the upcoming mid-term elections. Such a view seems to be etched into the WTI crude oil futures market and amongst the majority of American oil and gas executives. Although the futures market should not be considered a forecast, it shows WTI coming down to Post-War Oil Picture Permanently Altered?The more arcane question is what impact the war will have on the post-war global oil market. In the shorter term, it seems reasonable to believe that prices might remain elevated (vs. pre-war levels) as it takes time for shut-in production to return and a higher geopolitical risk premium lingers. But the longer-term outlook appears much harder to predict and is likely to be subject to a number of structural forces on both the supply and demand fronts. Two key potential developments that could support higher prices are: (1) greater stockpiling by net oil importers and (2) renewed efforts by the cartel (OPEC+) to curtail production in order to rebuild their fiscal reserve buffers. It’s not difficult to imagine that some Gulf states might end up suffering material damage to their longer-term growth prospects. On the other hand, two factors that could lead to lower prices are: (1) non-OPEC+ producers accelerate efforts to expand production capacity on the grounds of national security and (2) electrical vehicle adoption and the broader move to renewable energy accelerates. However, we still believe changes to incremental global oil demand are only likely to materialize gradually. Note that the latest Dallas Fed Survey shows a rather modest upturn in long-term projections (five-years out), with the mean averaging $79, compared to $75 in early December (Chart 4). However, there is now a much wider variation in where long-term prices are heading considering the multitude of risks. Key Takeaway: Forecasting oil remains an extremely tricky task, which is in part now highly dependent on the date that the projections are finalized. Given the war remains very fluid and could escalate/end at any moment, the risk of further (large) adjustments cannot be discounted. |
