The Macro Backdrop

A “No Hire, No Fire” Economy Continues

The war in the Middle East has brought about an elevated uncertainty quotient when examining the U.S. macro backdrop. The resultant rise in energy prices is being looked at as both a potential ‘tax on the economy’ as well as a catalyst for a near-term elevation in inflation.

Against this backdrop, it is important to turn the calendar back to the late February, pre-war timeframe to try to garner some perspective on how the macro setting was performing at that time. The data that has been released as of this writing continued to show a somewhat mixed labor force backdrop, and a relatively solid consumer and investment landscape.

Looking ahead, the attention will be placed on not only any potential negative impact from higher energy prices, but also one needs to take into account the fiscal stimulus that should be provided by the One Big Beautiful Bill. In our estimation, these two forces may wind up essentially cancelling each other out, leaving us, once again, to focus on the state of the labor markets.

Although new job creation has slowed considerably, the unemployment rate still remains historically low and wages are growing above the rate of inflation. A continued positive development is the fact that the key leading economic indicator, weekly jobless claims, continues to reside at levels that are about 100,000 below where they were historically prior to a looming recession onset. So, for all intents and purposes, the “no-hire, no-fire” economy remains intact.

If the Middle East war moves into a more permanent de-escalation phase, or ends, we would expect energy prices to decline in measurable fashion. However, the scope of disruption has moved higher, and energy prices may not be able to completely reverse back to pre-war levels in the months immediately ahead. Nevertheless, the underpinnings of the U.S. economy came into 2026 on a relatively solid note and should help keep overall growth moderately positive.

Inflation: Looking Through Higher Energy Prices

The Middle East war has created an environment where one would think that any potential tariff-induced inflation fears were being outweighed by concerns of any pass-through from higher energy prices. However, investors were learning that even though some measure of inflation, such as core CPI was returning to a more disinflationary pattern in recent months, but it still remained above the Fed’s preference.

That brings us to the Fed’s preferred inflation gauge, the core PCE deflator. Unlike core CPI, this measure has actually been trending to the upside on a pre-war basis. Indeed, the year-over-year reading stands at +3.1% as of this writing. This figure is not only more than a full percentage point above the Fed’s target, but it is also at its highest reading in almost two years.

That brings us back to the energy component of the equation. As we mentioned earlier, even with a more permanent de-escalation or end to the Middle East war, energy prices should fall but may not get back to their pre-war readings in the months immediately ahead. Thus, the economy will be dealing with a higher energy and energy-related product (oil, gasoline, plastics, etc.) price backdrop than what was the case back in late February before the war began.

The potential challenge will be to see if the markets can look through any war-induced increases to inflation and focus instead on underlying demand pressures. In addition, as Fed Chair Powell has stated, another key factor to consider is whether any potential increase in prices will be short-lived or have more of a persistent impact.

Either way, the Fed’s 2% target continues to be elusive.

Fed Policy: Between a Rock and a Hard Place

For the second consecutive policy gathering, the Federal Open Market Committee (FOMC) decided to remain ‘on hold’, keeping the fed funds trading range at 3.50%-3.75%. For the most part, this result was largely expected by the markets. Unfortunately for the Fed, the policymakers are in a challenging position of juggling incoming economic/inflation data as well as the uncertainties emanating from the Middle East war.

Against this backdrop, both the Fed and the broader investment community are left wondering what could come next from a monetary policy perspective. One thing to address upfront is that despite the surge in energy prices, the Fed will not be entertaining any potential rate increases. Rather, the voting members remain in a data dependent mode that should continue to argue for a more patient approach to the decision-making process. This last point is underscored by the fact that the FOMC just cut the fed funds rate by 75bp from September through December of last year. In other words, it’s not as if the Fed is really ‘behind the curve’ at this point.

In our opinion, the Fed will attempt to ‘look through’ the recent surge in energy prices. Yes, this development has created a noteworthy shift in inflation fears, but the policymakers, at this point anyway, seem to be operating under the assumption that any elevation in price pressures from higher energy costs will not be a permanent development.

While the Fed appears to be in wait and see mode, the bottom-line takeaway is that the financial markets will be operating in a scenario where rate cuts are either near, or at the end, of this easing cycle.

Searching for GeoAlpha

There was Greenland. Then there was Venezuela. Now there is Iran. The first two were rather inconsequential for risk assets. Greenland led to the U.S. admonishing NATO relevance. That was nothing new. The Venezuela operation was over before most knew it started. These events were certainly gamechangers in their own ways. Venezuela is now a pseudo friendly petro state in South America. Greenland reinforced the need for Europe to continue to develop its own defense capabilities and technologies. But–to a significant extent–they were not radical changes to risk asset landscape. The U.S. had already been pressuring NATO. And Venezuela was sanctioned to the point of irrelevancy by the U.S. and Western allies.

Those two are fundamentally different from the conflict in the Gulf. War is not the same negotiation as Greenland, and Iran is not the same as Venezuela. This creates a different risk matrix going forward. Oil prices have spiked as crude exports have been limited, and Iran has attacked its neighbors. And–without the Strait of Hormuz fully open and traffic normalized–disruptions in the energy market will continue to ripple through the global economy. It is important to look at the most probable outcomes of the conflict, and what that means for allocations.

Those outcomes are rather convoluted. But there are some common denominators. One of the more important is the rise in a geopolitical risk premium across multiple asset classes. That is likely to be “sticky”. While oil and its derivatives have declined with the announcement of a two-week ceasefire, there will also be a lingering geopolitical premium (for better or worse) priced into markets. That should be kept in mind. But that will also lead to a further resilience of supply chains and energy production. If there was one thing companies and governments learned from past issues (COVID, Ukraine, and tariffs), it was the necessity of derisking their business models. The current geopolitical backdrop is only going to reinforce this shift and accelerate it.