Macro Musings:
Thus far hopes the economy would accelerate in 2026 has proven misplaced with Q1 GDP revised to only 1.6%. This weakness is at odds with Atlanta Fed GDP Nowcast, which started at over 5% Q1 GDP and headed lower as Q1 progressed. For Q2, inventories may improve as inventory-to-sales ratios for manufacturing and trade sales normalize to pre-COVID levels, and real spending on health care may improve post a sharp rise in Q1 health services inflation.
However, the bulk of growth is still being held up by expectations, with asset prices driving wealth effect spending for high earners, while real household incomes fall, and with AI optimism being the sole driver of business investment. With the personal savings rate having reached a decades low, sustainable growth is out of reach until new job creation pushes aggregate income growth higher.
Small businesses are unlikely to drive the jobs market turnaround, with the uptick in ISM, NFIB, and Intuit employment reversing to, or remaining in contraction. Combined with rising median weeks unemployed, there is little to suggest an improving labor outlook.
Tariffs and energy prices remain the most significant inflationary pressures for the economy. However, the peak tariff effect on goods prices have likely been reached as the average effective rate falls below 10%, and the passthrough of oil into core inflation remains limited to just temporary fuel surcharges. Going forward, we expect disinflation to continue, especially in shelter/housing.
Market Thoughts:
We continue to maintain that energy markets will reprice quickly once the strait of Hormuz (SoH) reopens this summer as the incentives for oil producers will be to oversupply in order to jump start USD cash flows that have gone missing for over 3 months. If so, oil futures will go deeper into backwardation as distant oil contracts collapse towards 75 or below a barrel. Granted, all this hinges on a US/Iran agreement soon, likely as a multi-part process that sees the SoH open first before other details are ironed out.
Since the start of the Iran conflict US real rates were the primary driver of the Treasury sell-off, followed by widening of inflation breakevens and a brief spike in the term premium. Although rates have been largely in lock step with oil prices, again capturing inflation concerns, we think this trend will end once stock/bond correlations flip. Overall rates may have reached their 2026 peak.
The stock market has both climbed the wall of worry (the war) as well as the wall of higher rates on the back of better earnings and Ai driven dreams. This has occurred while various equity metrics (fundamentals, positioning and valuations) are at extremes. There is leverage embedded in many structures (ETFs, options market, outright margin etc.) and technical signals (divergence trends etc) suggest we are near a local, if not a major, top. Once momentum and euphoria fades, we believe that a decent sell-off in the stock market this summer will end up triggering a seasonal rates rally.
Fed and Rates View:
We view incoming Fed Chair Kevin Warsh downplaying the need to hike rates in this current highly uncertain environment and instead will aim to build consensus at the FOMC. We see Chair Warsh eventually shifting the focus to a new inflation target and arguing Ai productivity gains will lead to disinflation. We still see Jackson Hole as the rallying-cry time to line up cuts later in 2026.
Rates Update: We expect an eventual reopening of the Strait of Hormuz (providing relief on energy and inflation prints ahead). Meanwhile we continue to view the US economy as very fragile and at risk of a growth relapse in the 2nd half of 2026. The only areas of growth remain in Ai adjacent industries or attached to wealth driven consumption (where both are at the mercy from tightening of financial conditions post a major risk-on period).
If we see a combination of eventually lower oil prices, persistent weak labor markets, downside to US growth, these factors alone could drive rates markets to price-in cuts with the Fed delivering on them. Thus, we continue to expect two more rate cuts later in the year with risks coming from the timing of those cuts. And if stocks ever corrected course, that too would likely drive rate cuts.
We argue that rates may have seen the highs for 2026 in May. Yet we have once again have had to shift our forecast up 12.5bps across the curve for 2026-point estimates (listed on slide 36) to reflect a Fed on hold for longer amidst fiscal policy concerns.
Special Topic – Private Credit: A Macro Connection:
Concerns over private credit (PC) have come and gone in 2026, but we argue were it not for the Iran war, PC issues would still be in the headlines. As a refresher, PC woes were initially linked to several high-profile defaults, a series of redemption stories, and concerns over little transparency around valuations of the underlying loans sitting within private credit-based portfolios.
The market structure of private credit investing provides the industry with buffers from losses, primarily due to long lock up periods and redemption limits, which has kept the market intact despite recent concerns over underlying private lending values. We do worry about inherent leverage and potential for funding mismatches (resulting in hidden risks) where multiple layers of lending commitments and upcoming roll-over risk could have a domino effect in a worst-case scenario, specifically seeing PC actors sell public assets to raise liquidity to fund capital calls.
For now, we do not see enough evidence to suggest private credit, on its own, is a systemic risk to the banking system at large (although it may become an issue for insurance firms). However, since private credit is the marginal provider of credit (especially to middle-market firms), it's an increasingly important driver of the US macro-outlook. We see this through the large growth in non-depository financial institutions (NDFI) lending, which has been the main driver of credit availability within the economy.
Please see the PDF report link above for the full write-up with charts and forecasts…