Q2 2026 Market & Economic Outlook

 

Current Economic Views

Most estimates earlier this year projected stronger economic growth for 2026. The war in Iran dented near-term growth prospects, but the narrative for overall growth remains in place. The One Big Beautiful Bill Act is stimulative in the near term, and the Generative Artificial Intelligence spending spree continues.

 

While the pace of job growth has slowed, the unemployment rate remains low at 4.3%. On average, about 68,000 new jobs have been created each month this year. This represents a slowdown but is not alarming. The country simply has less labor demand to sustain economic growth due to technological productivity gains, restrictive immigration policies, and baby boomers aging out of the workforce.

 

In March, the Federal Reserve maintained its 2026 unemployment rate projection at a low 4.4%, slightly increased its GDP forecast to 2.4% from 2.3%, and raised its core inflation outlook to 2.7% from 2.5%. While the Fed left a potential interest rate cut on the table in its forecast, other projections see that as unlikely.

 

The price of oil jumped to over $100 per barrel from about $70 per barrel prior to the war. Consequently, by the end of March, the average price of a gallon of gas nationwide was up to $4, up from $3 in February. Supply chain issues stemming from the Strait of Hormuz also increased the cost of global fertilizers. Rising fertilizer and diesel costs will likely lead to higher grocery prices.

 

Trade remained in the headlines. In February, the Supreme Court struck down several emergency-related tariffs. The White House responded by using another legal channel to extend them for an additional five months at 15%. After the Supreme Court ruling, thousands of companies filed lawsuits for tariff refunds.

Looking ahead

The U.S. economy is large, diverse, and dynamic, and has remained relatively resilient through the first month-plus of the war. Consumers and businesses are facing rising energy prices, but we expect growth to “bend, not break.”

 

Growth forecasts outside the U.S. have been significantly downgraded, as Europe and Asia are more dependent on Middle Eastern energy. In comparison, U.S. GDP forecasts have remained stable, above 2%. Bloomberg’s consensus estimate for a near-term recession is near 30%, which is low.

 

Last spring, the economy faced uncertainty related to the Liberation Day “Tariff Tantrum” and this spring is facing the challenge of the war-related “Tanker Tantrum.” However, the U.S. is more energy-efficient now than in prior decades. Business and consumer confidence should tick up, leading to increased spending, once Middle East trade routes reopen.

 

Inflation has remained above the Fed’s target for five years now and is likely to rise further in the near term. However, the bond market expects annual inflation to average around 2.5% over the next five years.

 

While oil prices are hovering above $100 per barrel, futures contracts are pointing to roughly $85 per barrel later this year.

Current Investment Views: Equities

The S&P 500 had a rough start to the year, declining 4.35% in the first quarter. March was a particularly rough month due to spiking oil prices.

 

Energy was the winning sector in the first quarter with returns near 38%, by far the biggest increase. Materials had the second-highest increase, with returns above 9%. On the flip side, the Information Technology and Financials sectors declined by roughly 9%.

 

Based on their market cap, the Magnificent 7 companies continue to drive the S&P 500 and can be large contributors or detractors from performance. Last quarter, some of the major individual movers to the upside include SanDisk, returning over 164%, and LyondellBasell Industries, up 96%. This is also the second consecutive quarter that SanDisk has posted one of the largest gains, and it is now up 2,300% in one year. On the downside, AppLovin fell 43%, and Robinhood Markets declined 41%.

 

Equity markets have been driven into heavy volatility this quarter by geopolitical issues in the Middle East and the ensuing disruption to oil and gas markets. Despite all the volatility, the markets have been range-bound with the S&P 500 essentially trading sideways since November. We did not see any persistent downtrends until March, once again due to uncertainty on how long the conflict in Iran will last and the fallout at the conclusion.

 

Even though the war in Iran dragged stocks lower at the end of the quarter, earnings estimates for later this year are rising. The labor market is stable, AI spending continues, tax cuts are now in effect, and U.S. consumers (especially on the high end) remain resilient.

Looking ahead

Going into the second quarter, equity markets will be heavily influenced by the direction and duration of the war. The longer it goes, the more disruptive it becomes across multiple areas, including energy flows, trade, and business and consumer sentiment.

 

Spending on AI and data centers should continue, as spending announcements in 2026’s first quarter outpaced 2025’s first quarter. Also, calendar year 2026’s AI-related spending will likely beat 2025’s total. The major AI providers state that demand still far outpaces supply and it could take time to find a balance.

 

There are several key events and risks we are watching in the second quarter that will have major implications for equity markets. Those include a new Federal Reserve chair likely to take over in May, resumption of trade and tariff negotiations after the Supreme Court ruled the previous tariffs were illegal, and the impending midterm elections.

 

AI stocks will require even greater growth to support their high valuations. If this slows for any reason, AI-related equities are likely to decline. For now, a slowdown does not appear in the forecast. The AI movement is still in its early innings, and the U.S. and many other economies are banking on the technology to improve productivity as baby boomers retire.

Current Investment Views: Fixed Income

The Federal Reserve left rates unchanged at 3.50-3.75% in the first quarter amid a constantly changing economic landscape. During the quarter, the 10-Year U.S. Treasury Yield rose 14 basis points to 4.31%, and the 2-Year U.S. Treasury Yield rose 32 basis points to 3.79%. Reasons for the increase in yields across most of the curve include:

 

• The Iran Crisis pushed oil inflation expectations higher in the short term. Supply disruptions in the Strait of Hormuz drove up oil and natural gas prices, which will eventually flow through to transportation costs for goods.
• Increased short-term inflation expectations put the Fed on hold from its rate-cutting cycle. Three rate cuts priced into the market by January of 2027 quickly evaporated.
• Long-term rates are driving higher, mostly due to the expense of war. The cost of replenishing weapons and artillery, repairing warships and planes, restocking oil reserves, and large military actions will have to be paid for in the future. Increased debt issuance was already a concern for those following the Treasury market, and military costs will only add to those worries.

 

Inflation expectations and the MOVE Index (a measure of volatility) are slowly ticking higher in the fixed-income market. Credit spreads are also slowly creeping wider. These metrics are currently not alarming, but they have been worsening. However, the resilient consumer theme largely remains intact, keeping the bond market from having a larger reaction. Overall, the path of least resistance appears to be good economic growth.

 

The longer-term inflation component of Treasury Inflation-Protected Securities (U.S. government bonds that adjust their principal with inflation) has not moved significantly. This signals the bond market is looking past the current oil inflation and does not see it as a long-term issue (for now).

Looking ahead

In the Fed’s latest economic projections, the median real GDP growth for 2026 increased to 2.4%, above the Fed’s previous estimate of 2.3%.

 

Core PCE (the Fed’s preferred inflation metric) was revised higher to 2.7% for 2026 from 2.5% earlier. Some inflation metrics were trending in the wrong direction even before oil prices rose due to the war centered in Iran.

 

The median unemployment rate projection for the end of 2026 remained at 4.4%, suggesting a stable job market.

 

However, the dispersion of projections is extremely wide due to economic uncertainty across several fronts. Overall, Fed members appear more hawkish than at the end of last year.

 

Kevin Warsh, President Trump’s pick to replace Powell as board chair in May, will likely be unable to build an overwhelming consensus for lower rates unless the economy weakens significantly.

 

It will be interesting to see how Warsh responds to Trump’s desire for lower rates, even though inflation is still above target (assuming Warsh becomes the new Fed chair). Jerome Powell, the current Fed chair, can remain on the board after his term as chair ends in May, but he has not said what he plans to do.

Asset Spotlight: Global Debt

The U.S. public debt garners a lot of justified headlines, but the U.S. is not the only country spending money now and figuring out how to pay for it later.

 

The Wall Street Journal recently reported that global public debt exceeded $100 trillion. Many of the largest developed economies continue to deficit spend, boosting short-term economic growth but likely negatively affecting long-term growth and creating inflationary pressures. The recent spike in energy prices only exacerbates the issue as countries try to shield consumers from cost increases.

 

Below are the largest economies and how their public debt levels have changed since 2019:

 

• U.S.: $38.8 trillion of debt, up by 67% from 2019
• China: $20 trillion of debt, up by 140% from 2019
• Germany: $2.7 trillion of debt, up by 15% from 2019
• India: $3 trillion of debt, up by 43% from 2019
• UK: $4 trillion of debt, up by 41% from 2019

 

(Japan is the world’s fourth-largest economy, but its debt level is essentially flat. Also, some countries, like Germany, have recently made gradual progress on their debt. However, the ten largest economies are accruing more debt in aggregate.)

 

The U.S. debt-to-GDP ratio is roughly 121%, which is in the ballpark of some emerging economies like Sudan and Bahrain. Debt-to-GDP ratios are similar to a credit score and are an indicator of a country’s ability to pay back the debt it takes on. The U.S.’s figure is likely to climb since spending continues to outpace revenue.

 

It is commonly accepted that countries will incur additional debt to keep various priorities functioning during downturns. However, the global economy has generally performed well, making the spending and interest costs more precarious. When the global economy eventually contracts, the debt could look even worse, as tax receipts fall.

Looking ahead

Most of the largest economies saw increases in their debt-to-GDP ratios from 2019 to the present. The higher these ratios go, the bigger the headwind they create for overall economic growth in the future. Countries can address the problem by reducing their spending, increasing their GDP, or raising revenue.

 

Perhaps obviously, the increasing debt loads cannot continue forever.

 

The increasing debt load could have ramifications down the road, such as interest payments crowding out other priorities in the years to come. The U.S. is already paying roughly $1 trillion in interest annually, making it one of the government’s largest expenses. Furthermore, the Trump administration recently asked Congress for $200 billion for the war in Iran.

 

Countries with high debt loads may be incentivized to let inflation rise, since debt is nominal and, in theory, then cheaper to address. Inflation has been stubbornly sticky for several years now and is a leading cause of poor consumer sentiment in many countries.

 

Unfortunately, few policymakers (especially in the U.S.) even discuss this issue, let alone propose ways to address or reduce it.

 

The issue may also have investment implications. Consider diversifying bond holdings beyond U.S. government debt to include corporate or international bonds, private credit, or other conservative investments.