1Q26_ Quarterly Outlook Report_Final_EN - Flipbook - Page 12
T H E P LUMB LI N E | A RETU RN TO F I RS T PRI N CI PL ES
supported by solid earnings growth and beats, as well as expectations of lower interest rates. The
strength in equity markets has supported consumption growth despite headwinds to such
spending. Our work suggests that about a third of the growth in the United States over the last
year results from the gain in financial wealth since late 2023. Given current valuations and the
macroeconomic outlook, there is a greater risk than usual of a correction. A major correction,
were it to occur, would result in significantly weaker economic activity in the future, creating the
conditions for a self-reinforcing loop of weak growth and earnings. This is only a risk, as markets
and the real economy can and have diverged from each other for extended periods in the past.
This may well be the case going forward, but the point is that some of the surprising resilience
seen in some economies over the last year can be attributed to equity market performance. If
that support fades, the global economy will have one less crutch on which to rely.
Linked to uncertainty about inflation dynamics is the future path for U.S. interest rates. We expect
the Fed to cut its policy rate to 3% through 2Q26. That is more rapid than markets currently
anticipate. It reflects our view that inflation will cool more rapidly than forecast by the Fed
because we see the U.S. economy as having less momentum than others.
In addition, we cannot fully discount diminishing operational independence of the Fed as it sets
policy going forward. Chairman Jerome Powell and his colleagues are under tremendous
pressure to cut interest rates to satisfy President Trump. The President has frequently indicated
that he would like to see the policy rate up to 3% lower than current settings. We do not think this
pressure will succeed, but those that are angling to replace Chairman Powell in May will be heavily
influenced by the president’s perspective. Fed decisions are taken by committee, and the vote of
the chairman’s is only one of 12 – so unlikely to be consequential on its own, but it would be
difficult to ignore the power of the new chairman’s statements if they favour additional cuts when
the majority of the FOMC does not.
Likewise, there is uncertainty with respect to the how the president deals with accumulating
evidence of a slowdown in the consumer economy. One early sign is the promise of US$2,000
tariff relief cheques for certain households. Even though Treasury Secretary Scott Bessent has
indicated that he hoped households would save those relief payments, it seems clear a significant
proportion would be spent. That would boost growth and inflation in the short term and could
well lead to less of a policy rate reduction. More broadly, it is difficult to see how an administration
that seems to be so carefree about fiscal outcomes would not respond to weaker growth going
into an important mid-term election without some attempt at fiscal stimulus. Bond markets have
not internalized this risk yet.
In addition to the uncertainty associated with the dynamics noted above, it seems clear to us that
generalized uncertainty will continue to cloud the outlook. As U.S. mid-term elections approach,
there is a risk that disappointment on trade outcomes could trigger an amplification of trade
actions by President Trump. This would fly in the face of recent measures reversing tariffs to
address cost-of-living issues, but a central tenet of Trumpian economics is that trade deficits are
harmful. Consequently, we expect continued ambiguity in the trade space in the coming months.
Geopolitical developments could also have important implications for global markets. This holds
particularly true for Latin America following the U.S.’s exfiltration of Venezuelan President
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