The first quarter of 2026 witnessed a mix of geopolitical and market events in rapid succession: The war, oil and consequences for the markets. There were major global headlines throughout the first quarter, and, on the home front, the tariff package was struck down by the Supreme court, a new chairman of the Federal Open Market Committee (FOMC) was named, and the economy continued to struggle with labor market weakness and issues with K-shaped growth and consumption patterns. Throughout this turbulence, the markets remained resilient, generating modest gains, which makes it tough to form an accurate economic outlook.
This held until the U.S. initiated military actions (along with Israel) against Iran, which changed everything. Stock prices quickly moved lower and continued to deteriorate throughout March as the conflict escalated. By the end of March, the S&P 500 had lost 5.00%, taking year-to-date (YTD) returns down to -4.35%. Since then, markets have rallied on news of negotiations, recovering to reasonable gains for YTD.
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Rate cuts stymied
The war in Iran has quickly become the primary focus of the media and markets, largely because it immediately resulted in a closing of the Strait of Hormuz, shutting off roughly 20% of the global supply of oil. Oil prices spiked dramatically, rising nearly 70% in March. This has ignited concerns over upward pressure on inflation around the globe (with inflation in the U.S. already running well above Fed targets).
Hopes for two cuts to overnight rates evaporated and interest rates started to push higher. The longer the conflict rages, the greater the pressure on inflation and interest rates, which is particularly severe in economies outside the U.S. If the closing or severe restriction of the Strait are prolonged, this will lead to “demand destruction” as higher costs for gasoline and anything containing petroleum products will presumably begin to crowd out purchases of other goods and services.
Inflation, consumer sentiment took a hit
The Iran conflict is now the primary factor affecting the economic and market outlook for the remainder of 2026. There were ongoing weaknesses within the U.S. economy before the Iran conflict erupted, and those issues persist, along with some encouraging hints of activity.
If the Strait of Hormuz remains closed into late-May, it is likely that upward inflationary pressures and eroding consumer sentiment could cause a meaningful deceleration of economic activity around the world, potentially pushing us in the direction of a global recession.
While an agreement could be reached at any moment, it appears unlikely that Iran will fully agree to the U.S.’s primary demands (which are to turn over their uranium stores and ensure that the Strait stays open). Therefore, we are prepared for these negotiations to remain choppy, with military flare-ups possible for months to come. The critical economic questions are when and how tanker traffic will be restored in the Strait. The futures market for oil continues to indicate that the Strait will open and prices will normalize within a few months.
Primary market themes to know
The U.S. stock and bond markets have been surprisingly resilient, given the breadth and magnitude of some of the geopolitical shocks that have occurred over recent months. Market volatility will be high, and corrections in the normal range are possible (as much as -15%). But, we are still projecting 8-12% equity returns in the U.S. for 2026.
- Inflation: The spike in oil is certain to push inflation higher, likely to the 3.20-3.50% range, depending how long oil stays elevated.
- Economic momentum and GDP: Consumption continues to be surprisingly robust (although driven primarily by higher income households). But, if oil spends another month above $90/barrel, U.S. GDP will likely drop by at least 40-50 basis points in 2026.
- Wealth effect, K-shaped issues and consumption: It is estimated that as much as 90% of equity ownership resides within the top 10% of households (by income). Wealth expansion and income growth appear to be driving very strong consumption patterns amongst the wealthiest households in the U.S.
- Challenging economic and job data: Payroll growth in the U.S. slowed dramatically over the last 6-9 months, with monthly job gains averaging near zero for much of the last year. Delinquency data continues to show signs of weakness and savings rates have fallen to near record lows. In aggregate, the average U.S. household is getting by but struggling to keep up with the rising cost of living. There are some encouraging signs in recent labor reports, but we need more confirmation over coming months to believe that this trend has reversed.
- The FOMC: For now, the Fed is on hold, awaiting signs that inflation will stop rising before they can begin discussing rate cuts again. If oil and inflation do indeed fall later in the year, we foresee one rate cut, likely in the fourth quarter.
Economic outlook
We believe the risk of global recession due to the conflict is well below 50%, likely around 30-35%. The capital markets clearly agree with this assessment. We are closely monitoring all news of the conflict and are tracking numerous data points for signs of a meaningful deterioration in the longer-term outlook.
We are, for the time being, maintaining asset allocations in alignment with an outlook for positive economic and market outcomes in 2026.
Author: Eric Kelley serves as the executive vice president, chief investment officer for UMB Bank. In his role, he leads the bank’s economic forecasting team and sits on its asset liability committee as a voting member, helping to direct the company’s $68 billion balance sheet. In addition, he is responsible for the investment strategy for roughly $11 billion in client assets. Eric earned a Master of Business Administration from Baker University in Kansas City.
