Political and Economic Outlook

The first quarter of 2026 has reflected a slower (but still positive) phase of growth in the U.S. economy. Real GDP increased at an annual rate of 0.7 percent in the fourth quarter of 2025, while the unemployment rate held at 4.4 percent in February. Inflation has also moved well below its 2022 peak of 9.1 percent, with headline CPI rising 2.4 percent over the prior 12 months in February and core CPI rising 2.5 percent. While inflation has retreated substantially, even as domestic growth continues, it could begin to rise again if energy prices move higher and the conflict in Iran produces broader economic disruption.

The evolving situation in the Middle East has introduced a new variable which connects directly to energy markets, inflation expectations, and monetary policy. Policymakers have held interest rates steady while emphasizing that uncertainty around the outlook has increased. Rather than reacting only to slower growth, markets now face a wider range of possible outcomes shaped by developments outside the usual economic data flow. When geopolitical developments affect energy markets, the impact can often extend broadly to inflation, interest rate expectations, and asset prices.

Iran and Geopolitical Uncertainty

The sustained hostilities in the Middle East present a wide range of potential outcomes, and markets continue to adjust to that uncertainty. A contained conflict would allow investors to refocus on a domestic backdrop still supported by steady employment and continued growth. A longer disruption, particularly one that affects shipping through key energy corridors, would raise the likelihood of broader economic consequences.

The primary concern centers on the risk of escalation that disrupts energy infrastructure or transportation routes. The Strait of Hormuz remains one of the most important energy chokepoints in the world. The U.S. Energy Information Administration estimates that oil flows through the strait averaged roughly 20 percent of global petroleum liquids consumption in the first half of 2025. Markets do not need a complete shutdown to respond, only a higher probability of disruption, delay, or higher transit costs.

A sustained disruption would introduce renewed inflation pressure through higher energy prices. Supply constraints reduce available output and push prices higher across global markets. Those higher prices then flow through transportation, manufacturing, and consumer goods, allowing geopolitical developments to influence broader economic conditions.

Oil, Inflation, and Equity Markets

Energy provides the most direct transmission channel between geopolitical developments and economic outcomes. The U.S. enters this period from a different position than it held in earlier oil shocks. U.S. crude production averaged about 5.0 million barrels per day in 2008 during the financial crisis, compared with an expected 13.6 million barrels per day in 2026. That shift does not shield the economy from higher oil prices, but it does change how those prices move through the system.

Higher oil prices still raise gasoline and transportation costs for consumers, while also increasing input costs for businesses across the economy. Some companies absorb those added expenses, while others pass them through to customers, which can influence both earnings expectations and inflation. At the same time, higher prices can support income and activity in domestic energy-producing parts of the economy. The overall effect is more balanced than in earlier periods, and equity markets reflect that adjustment through changes in both pricing and sentiment.

Federal Reserve Policy Implications

The Federal Reserve's most recent decision reflects how these dynamics influence policy. In March, the committee held the federal funds target range at 3.50 percent to 3.75 percent and noted that the implications of developments in the Middle East for the U.S. economy remain uncertain. The Federal Reserve still sees inflation as above its 2.0 percent target. At the same time, policymakers recognize that some of the current risk comes from forces monetary policy cannot directly control.

Energy disruptions create a more complicated policy challenge because they represent a supply-driven shock. Traditional monetary policy works in part by influencing demand through borrowing costs, but it cannot directly increase the supply of energy. When oil prices rise because supply appears less secure, higher interest rates do little to address the underlying cause. This helps explain why the Fed has adopted a more patient posture rather than moving quickly in either direction.

The Fed's March projections still leave room for some easing later this year, but only slightly. The median forecast for the federal funds rate at year-end 2026 stands at 3.4 percent, which suggests only modest room for rate cuts over the remainder of the year.

Election-Related Political Uncertainty

The current election cycle introduces another variable that may influence market behavior this year. Election years can influence market sentiment in the near-term as investors assess the potential direction of fiscal, trade, and regulatory policy. Over longer periods, markets have shown a consistent tendency to look beyond political cycles and refocus on economic fundamentals. Earnings growth, productivity, and innovation have historically driven long-term returns across different political environments.

Portfolio Implications and Final Thoughts

Geopolitical events often generate alarming headlines, but over time markets have absorbed such shocks more resiliently than many expect. Market movements driven by uncertainty can feel significant in the moment, yet they do not always translate into lasting changes in long-term outcomes.

That perspective reinforces the importance of keeping portfolios aligned with long-term goals rather than reacting to short-term developments. In this context, portfolio construction matters more than precise prediction. A portfolio built around a single expected outcome will almost certainly falter when conditions change, while a portfolio designed to accommodate a range of outcomes tends to prove more durable over time. Diversification remains central to that approach, reducing reliance on any one view of energy prices, inflation, or policy direction while remaining well-positioned as conditions evolve.