Policy and geopolitics dominated the landscape in Q1, but there was no clear cyclical inflection point. The balance of the evidence suggests U.S. growth remains intact, neither buoyant nor fragile. A mix of disruptive forces—AI and the Middle East conflict most significant among them—point to an emergent reality: A structurally resilient domestic economy is operating in a less stable global system. Shocks are becoming more frequent and more central in shaping outcomes. The economy remains sturdy in our base case—supported by healthy households and an AI investment boom—but downside risk has increased.

In this outlook, we examine the state of the U.S. economy entering the conflict in the Middle East, discuss the long-term implications of a shifting global landscape, and provide views on the most pressing macro themes in Q2.

Macro house views

• Economic growth: U.S. growth has slowed somewhat but remains solid. Real final sales to private domestic purchasers—a cleaner measure of domestic demand—rose 2.4% in 2025, down from 2.9% in 2024. Stronger productivity has partially offset slowing immigration. GDP growth of 2%–2.25% is a reasonable 2026 base case, though tail risks remain elevated.¹
• Labor market: Job growth remains subdued, but the data continues to signal stability, if not dynamism. The unemployment rate has risen less than a percentage point since the end of 2022, with more than half driven by labor force entrants rather than job losses. Wage growth of around 4% has held steady for multiple years, supporting consumption while putting modest upward pressure on inflation.²
• Consumers: Real consumption growth has moderated to align with household income after a period of savings drawdown. Higher tax refunds should support spending into Q2, though rising energy costs may offset some of that boost. Full employment and steady wage growth should keep real spending growing at roughly a 2% pace.
• Businesses: Business investment remains solid but narrowly concentrated in AI-related sectors, excluding which capex has declined. Encouragingly, AI investment shows no signs of slowing, and improving ISM surveys suggest business spending could broaden—provided geopolitical risks ease.
• Housing: The Middle East conflict has reversed a steady decline in mortgage rates since last fall. The average 30-year fixed rate is now 6.5%, complicating the spring market.³ Home sales remain depressed, but limited supply is keeping prices stable. Construction activity is softening as builder margins come under pressure from incentives.
• Inflation: Core inflation was already moving in the wrong direction prior to the conflict, which will push energy prices—and headline inflation—higher. While the size and duration of the shock remain uncertain, wage growth and core services inflation continue to run more than a percentage point above 2017–2019 levels, suggesting the “resting heart rate” of inflation is higher.^1,2
• Monetary policy and interest rates: The Fed is likely to remain on hold in the near term as it assesses persistent inflation and the latest supply shock. Policymakers would typically look through energy-driven price increases, but repeated shocks raise concerns around inflation expectations. A new Fed Chair in mid-May adds another layer of uncertainty.

Asset class views

• U.S. equities: The S&P 500 posted its worst quarter (-4.4%) since 2022 amid AI disruption concerns and geopolitical risks. After driving more than half of gains over the prior three years, the Magnificent 7 accounted for nearly all of the Q1 decline. Valuations have retraced to Liberation Day levels, but at 19.5x, P/E ratios remain elevated. Downside risk dominates near term, though markets could rebound if geopolitical clarity emerges.⁴
• International equities: Ex-U.S. stocks outperformed the S&P 500 in Q1, driven largely by lower tech exposure. The valuation gap has narrowed over the past 15 months and is no longer historically wide. Higher commodity prices are likely to weigh more on developed markets in Europe and Asia than on the U.S., and emerging markets face the potential daunting dual challenge of expensive energy and a stronger dollar.⁴
• Core fixed income: Bonds were roughly flat in Q1, failing to offset equity weakness. Long-term rates rose as markets priced out Fed cuts in 2026. While some near-term relief is possible, persistent inflation and uncertainty around Fed leadership are likely to keep yields elevated, implying limited upside and continued volatility.⁴
• Cash: T-bill yields around 3.65% will likely remain stable through Q2 as the Fed remains on hold. With inflation persistent and likely to move higher due to energy prices, real returns on cash will likely approach zero.⁴
• Private equity: Investment activity has improved, but volatility risks disrupting the rebound in the near-term. Private equity has underperformed public markets over the past three years, creating a more attractive entry point. Opportunity appears strongest in the middle market, where valuations are lower and operational value creation is more achievable. In this environment, outcomes will be driven less by beta and more by manager selection and execution.
• Private credit: The asset class has come under scrutiny amid software sector concerns and redemptions in non-traded vehicles. Fundamentals remain healthy, with stable default rates and improving borrower interest coverage. Slower capital formation is allowing spreads to widen, improving risk/reward for new deployment.
• Commercial real estate: The real estate rebound continues to gradually progress. Investment volumes have seen a broad-based improvement and property values are stable (though not rising). Higher long-term rates could force cap rates to creep higher, keeping capital appreciation contained and returns predicated on income generation.