Couldn’t stand the weather: Energy shocks test markets

March 2026 highlights

Texas Flood: Another March, another crisis. The conflict in Iran has many investors looking back to the fallout of the Russian invasion of Ukraine in 2022. But initial conditions are critically important. Energy expenditures as a share of total consumption sit close to the lowest levels on record while labor slack continues to build, wage growth continues to cool, and household savings have been drawn down. This is not 2022. Downside risks to growth outweigh upside risks to inflation.

Crossfire: Markets have grown accustomed to these shocks as well and are currently reflecting a fairly short-lived inflationary impulse from the energy price shock with 1Y inflation swaps surging higher while 1Y1Y forward inflation swaps remain benign. This is partially a reflection of the market’s expectation that another TACO (Trump Always Chickens Out) moment from the Trump administration will eventually arrive as the administration looks for an off-ramp. But the current conflict is very different from the unilateral decisions of the tariff shock last year. Should energy prices remain higher, look for forward inflation swaps to move lower as the market prices in the disinflationary effects of demand destruction.

Tightrope: Common wisdom suggests that central banks should look through temporary shocks like the energy shock that we face as a result of the hostilities in Iran. But as the Federal Reserve System (the Fed) faces its fourth negative supply shock in the past six years at a time when the hawks were already gaining the upper hand, the Fed will likely be unable to look through the shock, at least for the time being. That means pricing out and pushing out cuts into 2027. The Fed will ultimately look through the price shock if growth shows signs of cracking, and given the skew of risks to the dual mandate, the market looks to be pricing an overly hawkish policy path.

Taxman: The central macro narrative entering the year was one of reaccelerating growth on the back of a stabilizing labor market, delayed effects of prior rate cuts, deregulation, and a fiscal lift from the One Big, Beautiful Bill. We’ve stressed that the consensus was overstating the stimulative effects of the tax cuts, and while it remains early in the filing season, it increasingly appears that fiscal impulse will disappoint those lofty expectations as refunds are running only modestly ahead of last year’s pace. Either way the conflict in Iran goes, the consensus appears to be still overly sanguine on the growth outlook.

Change It: It feels like ages ago that the market was myopically focused on the fallout of potential artificial intelligence (AI) disruption triggering a massive rotation under the surface of an index that has tread water to begin the year. AI disruption fears may have been the fundamental trigger, but offsides sentiment and crowded positioning were the fuel for the vicious churn out of yesterday’s winners into laggards and pockets of perceived AI immunity. While the dispersion has been painful for many names under the surface, perversely, it has helped to reset sentiment and positioning ahead of the conflict in Iran, potentially increasing the market’s resilience through the turmoil and cleaning the slate for gains on the other side.