“You have one tool, it can’t do two things at once.”
– Jerome Powell, Current Federal Reserve Chair
First Quarter Summary
As predicted, 2026 is turning out to be another volatile year, with most markets falling in the first quarter.
- Following a turbulent March, the S&P 500 declined 4.3% while the NASDAQ 100 fell 5.8%. Bond yields crept higher, with the 10-year Treasury yield rising from 4.17% to 4.32%.
- After remaining higher for most of the period, International markets dipped 1.1%.
- Commodities continued their wild ways. WTI oil was up a stunning 76% while Brent almost doubled. Gold rose 8.1% after selling off sharply in March.
Early Developments
After the capture of Venezuelan leader Maduro, tensions rose between US and Denmark over the future status of Greenland. The White House insisted on purchasing the territory while Copenhagen remained firm in its resolve to maintain control over the world’s largest island. While the situation is largely unresolved, both sides have agreed to negotiate a solution.
The AI situation has morphed from elevated capital expenditure worries by hyperscale companies like Oracle to entire industries (such as software) being severely disrupted. This argument is somewhat contradictory as both concerns cannot be true. In other words, if business models of industries are at risk, then the capex spending is showing results. This is indicative of a phenomenon in its early, rather than late stages.
Meanwhile, the future composition of the Federal Reserve Board remains undecided. With Chairman Powell’s term expiring May 15th, the President has nominated Kevin Warsh, a former Fed governor, as the new Chair. However, Mr. Warsh has yet to be confirmed by the Senate and several Senators are threatening to hold up the vote until a criminal investigation of Chair Powell is completed. To complicate matters further, Powell will remain as a Fed Governor even if his term ends and he has not indicated if he intends to stay. Additionally, the status of Governor Lisa Cook is still in the courts.
All of this will make it more difficult for the FOMC to reach consensus on interest rate policy, even though Warsh is leaning towards lowering the short-term Fed Funds rate. Although the Chair has the most influential vote on the Board, it still requires a majority vote to determine direction of monetary policy.
With these events occurring simultaneously, it appears the tariff dilemma has been placed on the back burner. In late February, the Supreme Court (SCOTUS) struck down nearly half of the Administration’s tariffs, prompting a temporary imposition of 10% tariffs with the option of an increase to 15%. Also, tariffs on specific industries such as steel, aluminum and autos were increased. The temporary levies will last until the end of July, at which time congressional action will be necessary for a more permanent solution.
Conflict in Iran
At the end of February, the US and Israel launched an aerial and naval bombardment of suspected Iranian nuclear facilities. The Administration’s stated goal of permanently disabling Iran’s nuclear program was amended to include the achievement of regime change. Tehran responded by drone and missile strikes against American military bases in the Persian Gulf, along with military and energy infrastructure in neighboring countries and Israeli military and civilian targets.
The situation escalated as liquified natural gas (LNG) plants in both Iran and Qatar were severely damaged. Additionally, supplies of oil going through the Strait of Hormuz (SOH) were effectively cut, with only ships friendly to the Iranian regime allowed to transit. In effect, about 20% of global oil and natural gas supply has been cut off.
The current state is extremely fluid, centering around a two-week ceasefire and reopening of the SOH. Negotiations on April 11th failed and the US has since launched a total blockade of the Strait. Although path forward is unclear, it is imperative that traffic through the SOH must be entirely restored to prevent the global economy from getting worse.
Beyond that, sticky issues such as Iranian nuclear enrichment and Israeli strikes against the Hezbollah in Lebanon remain to be decided. Regarding the global energy situation, the US is now a net energy exporter due to the advances in fracking technology. Countries in Asia and Europe unfortunately, are net energy importers continuing to be hurt by the supply shock.
The Outlook for the Second Quarter
TRP anticipated some of the current market volatility by adding energy stocks to portfolios early during the first quarter and adjusting international holdings to reflect longer term impact of higher energy prices. Here is the outlook for the next quarter.
- With energy prices likely to remain elevated for now, US inflation will climb higher, between 3.0-3.5%. Real GDP (inflation adjusted) growth may be clipped between 1.5-2.0%, although refunds from the new tax bill should offset the hit from higher gasoline prices to consumers.
- There is an outside chance (30%) of a US recession at worst, because the United States is a net exporter of energy. For a recession to occur, however, it would still take significantly higher energy prices with West Texas Intermediate (WTI) contracts sustaining levels of over $140 per barrel for several weeks. Currently, WTI is at $92.
- The employment picture will remain largely unchanged, with the “no hire, no fire” situation continuing.
- The Fed is likely to keep short-term Fed Funds rate steady until the Iranian conflict is resolved, which may take several weeks. We still see the probability of rate cuts, but recent events have pushed out the timetable until late in the year. Longer dated Treasury yields could creep higher due to inflation and US fiscal concerns.
- US equities should recover from their recent swoon, with corporate profits slated to rise in the low teens, continuing healthy growth. Volatility, however, could prevail the rest of the year.
- Keep in mind that mid-term election years usually cause more market volatility than non-election years. As the British used to say during World War II, “Keep calm and carry on.”