Economic Outlook

Labor Market: Cooling Without Collapse

The labor market is cooling unevenly, with payroll growth volatile, participation drifting lower, and hiring expectations softening — but no broad-based layoffs or collapse in employment. AI-driven restructuring is becoming a more visible labor headwind, as firms curb future hiring needs and reallocate spending toward automation and productivity investments.
 

Consumer Confidence and Spending: Discretionary Demand Under Threat

Consumer confidence has fallen to record lows, driven primarily by the rapid spike in gasoline prices and rising inflation expectations, even as spending among higher-income households remains relatively resilient. Higher gasoline and consumer staples costs are increasingly crowding out discretionary spending, with travel, leisure, and big-ticket retail most exposed to sentiment and fuel price shocks. Credit risk is rising for sub-investment-grade issuers reliant on volume growth.
 

Monetary Policy: Limited Flexibility, Prolonged Hold

Monetary policy flexibility is limited, as energy-driven inflation and higher inflation expectations suggest a prolonged Fed hold and fewer expected rate cuts. Bond investors are now nearly certain that there will be no rate cuts in 2026, and if inflation expectations begin to drift higher, the FOMC may even be tempted to tighten policy with a rate hike. Market-implied odds from the CME FedWatch Tool suggest that near-term rate cuts are unlikely, with futures pricing showing a very high probability that the Federal Reserve holds the policy rate steady at the next several meetings, and only a gradual rise in cut probabilities later in 2027.
 

Manufacturing: Expanding, but Cost Pressures Are Severe

Manufacturing has returned to expansion, but with severe cost pressures and contracting employment, while services continue to grow more slowly and show rising sensitivity to global risks. Energy-intensive manufacturers — including chemicals, metals, and building materials — face rising input costs, and firms with just-in-time supply chains or Middle East exposure are more vulnerable to working capital stress. There’s also potential for rating outlook pressure if volatility persists beyond one quarter.
 

Housing: Demand Can’t Overcome Affordability Headwinds

Housing remains constrained by affordability, as mortgage rates, rising inventories, and higher input costs weigh on activity and builder confidence, despite underlying demographic demand. Higher oil prices are adding to cost pressures by lifting diesel, transportation, and energy-intensive material costs, such as cement, steel, and asphalt. As cost uncertainty and margin pressures mount, builders are growing more cautious, scaling back starts or delaying projects, further weighing on confidence.
 

Financial Services & Credit: Second-Order Credit Risks Rising

Banks face second-order credit risk rather than direct exposure, with stress in transportation, manufacturing, and consumer portfolios. In this environment, counterparty and market liquidity risk monitoring becomes more important than headline default risk. A sharp correction in the stock market — especially if not quickly reversed — would reduce wealth and spending, triggering layoffs and a potential recession.
 

Downside Risks: Oil, Geopolitics, and Policy Uncertainty Dominate

Downside risks dominate the outlook, with oil prices, financial market volatility, tariffs, and geopolitical escalation posing asymmetric threats to growth — even as the risk of recession is not the base case. The principal risk scenarios include:

• Sustained elevated oil prices above $100 a barrel crowding out consumer spending and raising input costs across sectors
• Financial market volatility triggering a wealth-driven slowdown in consumption and investment
• Monetary and fiscal policy missteps in response to energy-driven inflation
• Geopolitical escalation stemming from the Iran conflict, with further disruptions to global energy supply chains
• Tariff uncertainty adding to already elevated policy uncertainty and softer business investment
   

Economic Outlook: Cautious Resilience, Asymmetric Risk

The current macroeconomic picture is one of cautious resilience under mounting pressure. The U.S. economy is growing, but the margin for error has narrowed considerably. The Iran conflict has emerged as the single most consequential variable in the near-term outlook, driving energy costs higher, reigniting inflation, and restraining the Federal Reserve at a moment when policy flexibility would otherwise be welcome. Across sectors, the stress is uneven but directionally consistent: manufacturers face input cost squeezes, homebuilders are pulling back, consumers are losing confidence, and credit portfolios are absorbing second-order shocks. AI-driven productivity gains offer a genuine medium-term tailwind, but that promise does little to offset the immediate headwinds from energy, geopolitics, and policy uncertainty. The base case remains a soft landing, but the distribution of outcomes has shifted meaningfully to the downside — and portfolio strategy should reflect that asymmetry.