In 19th century English novels, so-called “quarter days” often provided a chronological backdrop to the plot. A relic of medieval times, the quarter days were Lady Day (March 25th), Midsummer Day (June 24th), Michaelmas (September 29th) and Christmas Day (December 25th). These were the dates upon which rents were paid, leases expired and employment contracts took effect. Quarter days were often when the landlords of Austen expected their income, the impoverished families of Dickens had to cough up their rents and the farmworkers of Hardy would move on to their next place of employment. In short, they were days of accounting and reckoning.
The timing of economic data and events in the U.S. provides a different but equally auspicious set of dates upon which to assess the economy and financial markets, namely the first weekend of the second month of each quarter. By that weekend, we normally have a hot-off-the-presses first reading on GDP for the prior quarter, the majority of the earnings season behind us and a just-concluded FOMC meeting. And so last weekend seemed like a good time to reassess the state of the economy as it pertains to financial markets.
Doing so, in 2026, however, first requires a review of the headwinds and tailwinds impacting the outlook. So here, in brief, is an assessment of the forces shaping the economy in the spring of 2026, what we think they imply for the outlook for growth, jobs, profits and inflation, some thoughts on likely monetary policy and some investment implications.
Headwinds and Tailwinds
There are five broad forces currently distorting the short-term economic outlook, namely, oil, immigration, tariffs, AI capital spending and fiscal stimulus.
On Oil, the Iran war has now entered its third month, with a temporary ceasefire but also a U.S. blockade of Iranian ports, a de facto Iranian blockade of the Strait of Hormuz and no sign of any resolution of the underlying nuclear issue. We continue to believe that the U.S. will eventually accept an agreement by which the Strait is reopened before more extended negotiation on the nuclear issue. However, timing is important here. Every day the Strait is closed, global oil inventories fall. This has actually had a somewhat muted impact on oil prices so far, since the world entered 2026 with near-record high stockpiles of oil and oil products. These inventories fell rapidly in both March and April and, if this continues for a few months more, then oil prices could move much higher. However, before this fully plays out, it should become a more urgent issue for the U.S. administration due to the political cost of fast-rising gasoline prices and our baseline view is one in which traffic through the Strait resumes close to normal patterns within the next two months, with global oil prices falling sharply although not to pre-war levels.
On Immigration, the broad picture remains one of much diminished illegal and legal immigration. Encounters at the southern border were less than 12,000 in March, continuing the pattern of the last year. This is in very sharp contrast to almost 200,000 per month as recently as fiscal 2024 and, since most of the recent unauthorized immigrants are immediately detained and deported, this suggests virtually zero illegal immigration into the U.S. Meanwhile, arrests of unauthorized immigrants continued to run between 30,000 and 40,000 per month through March 2026, suggesting a pattern of negative net illegal immigration.
Legal net migration may well still be positive. However, while the State Department hasn’t updated its numbers since last September, in the three months that ended September 2025, immigrant visas were down 26% from a year earlier. It is quite possible that Census overestimated the pace of immigration when, in January, they projected net immigration of 321,000 for the year ended July 1st, 2026. However, even at this pace, the U.S. working age population would be falling by 20,000 people per month. Regardless of the results of the mid-term elections, we expect the administration to continue aggressive immigration enforcement through the 2028 presidential election, reducing labor supply.
On Tariffs, we appear to have passed the high-water mark for protectionism. When the Supreme Court struck down the IEEPA tariffs in February, the President announced the imposition of 10% tariffs under alternative authority and, within 24 hours, vowed to raise this to 15%. However, this 15% rate was never actually imposed and even the 10% rate is being challenged in the courts on multiple grounds.
Regardless of whether the 10% tariffs are eventually upheld by the courts, it is clear that the effective tariff rate has fallen. Net tariff revenue averaged 11.0% of total goods imports in the fourth quarter of 2025 but fell to just 7.3% of imports in March 2026. While the administration has promised that it will fully and permanently replace the lost IEEPA revenue with new tariffs under different authority, we think that this is unlikely to occur in a period of elevated inflation and we expect the average effective tariff rate in the fourth quarter of 2026 to be significantly lower than in the fourth quarter of 2025.
On AI Capital Spending, earnings reports from the first-quarter reporting season show a further step up in capital spending plans with the largest five hyper-scalers now expecting to spend roughly $725 billion in 2026, up from a prior estimate of $675 billion and far above the $416 billion they spent in 2025. To put these numbers in perspective, $725 billion equals just over 60% of all the money spent last year on U.S. home-building and home renovations, while the increase in hyper-scaler capex accounts, on its own, for about 17% of the increase we expect to see in nominal GDP between 2025 and 2026.
We expect this ramp-up in spending to continue. Major tech firms see AI as both an existential threat to their current business models and an existential opportunity for future growth. That being said, some of this pressure to grow will expend itself in higher prices and higher imports, neither of which benefit real economic growth while potential productivity gains from AI may further slow hiring among more cost-conscious corporations, adding some drag to the labor market.
And then there is Fiscal Policy. Data through April 17th show that, with roughly 83% of income tax returns processed, the average refund is up by $328 or 11.3% from a year ago with 65.2% of processed returns resulting in a refund, up from 62.3% a year ago. Still, the size of the refund bump is smaller than we expected based on calculations when the OBBBA was passed, and, for many households, the increase from higher gas prices entirely negates the impact of new tax breaks included in the OBBBA.
That being said, we still assume that the administration will try to include some broad stimulus in a reconciliation bill to be passed later this summer. From a political perspective, this could provide an advantage by making consumers feel a little better off ahead of the November elections. However, it would likely represent the last dollop of fiscal stimulus for the economy for some time since, if the Democrats take back control of the House of Representatives, as we expect, they are unlikely to support further unfunded stimulus before the 2028 election.
Economic Checklist
So how does all of this map onto a view of the economy?
On Economic Growth, first-quarter real GDP grew at a 2.0% annualized rate following a 0.5% gain in the fourth quarter. Over 90% of this gain came from increases in business fixed investment in equipment and intellectual property and, while we expect this capex boom to continue, it should decelerate a little over the rest of this year and in 2027.
Elsewhere, growth is likely to be more subdued with real consumer spending rising at a relatively steady 1.5% rate, home-building and state and local government spending growing very slowly, inventories declining a little, reflecting the impact of the Iran war on energy stockpiles and federal government spending increasing more quickly, due to the need to replace munitions used in the war so far. All told, we expect growth to slow to about 1% in the second quarter of this year, accelerate to 3% for the third quarter and then settle in at a 2% pace for 2027.
On Jobs, this pace of economic growth would normally be associated with monthly job gains of between 100,000 and 150,000. However, severe restrictions on labor supply due to lower net immigration could cut job growth to about 60,000 per month. Even this meagre rate of job growth should put some downward pressure on the unemployment rate which could slip from 4.3% currently to below 4.0% in 2027. However, a very depressed mood among workers, the competitive threat of AI and easing inflation after a summer 2026 surge, should hold wage growth in check.
On Profits, as of last Friday, with 72% of S&P500 market cap reporting, first-quarter pro forma S&P500 earnings per share were on pace to register an astonishing 24.5% year-over-year gain. However, it should be noted that just three companies have accounted for more than half of this year-over-year increase, largely due to accounting rules that required them to recognize one-time increases in the value of their stakes in AI companies or one-time tax benefits.
The government’s estimate of first-quarter adjusted after-tax profits should avoid some of this distortion and we expect it to post a more subdued but still very impressive 14% for the first quarter following double-digit year-over-year gains over the prior two quarters.
Moreover, there are some potential headwinds to profitability going forward. First, huge capital spending in recent years is setting up significant depreciation expense for upcoming years. Second, the ability of companies to use 100% expensing of R&D and capital spending in their tax calculations since the start of 2025 has boosted after-tax cashflow. However, it obviously reduces their ability to lower tax expense going forward as you can’t claim depreciation on investment spending that you have already 100% expensed.
Overall, while we still see the profit picture as benign, even in the absence of recession, year-over-year profit gains should sink to high single-digit gains from their current double-digit pace as we move into the second half of 2026 and 2027.
On Inflation, some further heating up is likely into the summer but then price increases should recede. In March, the Fed’s preferred measure of inflation, the personal consumption deflator, rose by 3.5% year-over-year and we expect this to rise to 3.9% year-over-year for May. However, thereafter, we expect inflation to drift down due to falling oil prices, lower tariff rates and a continuing slide in shelter inflation reflecting the impact of weaker demographics on rents. Inflation, as measured by the PCE deflator should fall below 3.0% year-over-year by December and below 2.0% year-over-year by April 2027.
The Fed and the Dollar
Last week’s FOMC meeting saw no change in interest rates, as expected. However, it provided further signs that the Fed is unlikely to reduce rates any time soon, despite constant pressure from the administration and the now very-likely confirmation of Kevin Warsh as Fed Chair. In particular, the decision by three members of the FOMC to vote against the statement because it continued to show an easing bias was a clear signal that the FOMC members won’t vote to ease unless and until they feel the data justify it. Moreover, Jay Powell’s decision to remain on the board beyond his term as Chair removes the opportunity for the President to nominate another dovish member to the board, at least for now.
While we don’t expect any Fed easing in the months ahead, we do think a rate cut could occur in December with possibly two more in 2027 if the economy is clearly on track to see less than 2% economic growth and less than 2% inflation next year.
Meanwhile, while other major central banks refrained from changing interest rates last week, the ECB, BOJ and Bank of England all look more hawkish than the Fed at this stage, setting up the potential for a narrowing in interest rate spreads between the U.S. and the rest of the developed world next year and a consequent resumption of a dollar decline.
Investment Implications
For investors, despite the geopolitical turmoil, it has been a positive year so far with a year-to-date total return of 6.0% for the S&P500. However, there has been some rotation out of mega-cap U.S. growth stocks with value stocks outperforming growth stocks and small caps outperforming large. International stocks have also done better than U.S. stocks with the ACWI ex-US generating a 9.3% total return year-to-date. Bond yields have drifted upwards reflecting higher inflation, sustained economic growth and the prospect of even greater government borrowing.
In this environment, and despite all the geopolitical uncertainty, it still makes sense for long-term investors to stay in long-term assets. However, as was the case at the start of the year, investors should consider rebalancing away from mega-cap growth stocks and towards areas with less lofty valuations including U.S. value stocks, international equities and high-quality fixed income. It also still makes sense to explore adding alternatives to portfolios for diversification. As was the case entering this year, the baseline outlook is positive. However, with valuations high and numerous risks to the financial environment, this quarter day is a time to consider risk as well as return in planning for the months and years ahead.