The U.S. economy is heading for a period of above-average inflation and below-average growth, driven by the effects of the U.S.-Israel war with Iran, according to data released by Oxford Economics.
In fact, the updated baseline forecast assumes that the global oil price averages around $113pb in Q2 before gradually declining. This is likely to push U.S. headline inflation sharply higher over the next few months, with prices expected to rise 3.3% this year, up from 2.7% in 2025.
The resulting squeeze on household real income, combined with the uncertainty generated by the conflict, is likely to weigh on economic activity, with growth to dip below trend over the next couple of quarters.
Key takeaways:
· Equities are likely to remain under pressure in this environment, before regaining ground later in the year.
· Oxford Economics‘ macro regime analysis shows that periods of high inflation and low growth have historically been associated with slightly negative real returns and underperformance compared to other asset classes. However, the risk of an outright recession – and a corresponding sharp decline in equity prices – remains low. The macro team's modeling suggests that a prolonged period of oil prices above $140 per barrel would be required for the U.S. economy to contract.
· The market has started to price in a more inflationary environment, but there could be further to go if the conflict in Iran doesn't de-escalate quickly. Since the beginning of the year, the pattern of industry group returns has most closely resembled previous periods of high inflation and low growth, with energy and defensives outperforming and consumer cyclicals lagging.
· Despite this trend, the relative beneficiaries of higher inflation don't look expensive compared to the relative laggards. Their average relative cyclically adjusted PE is back above its decade average, but remains well below the levels reached during previous inflationary episodes, such as 2022.
· The sector is among the most negatively impacted by rising oil prices and has been one of the few to see net downward EPS revisions over the past month since the outbreak of the war, alongside real estate and communication services.
· Within the sector, autos, and consumer durables typically fare worst in high-inflation, low-growth environments and are expected to underperform further in the near term. This shows that a 10% increase in oil prices relative to the prior three-year maximum is associated with a 2.1% reduction in overall durable goods spending. This compares to a 0.6% decline in non-durable goods consumption and a less than a 0.5% drag on services.
· Companies that cater to low-income consumers are also likely to suffer as they spend a much larger share of their income on energy goods and services. Expect the crisis to exacerbate the existing bifurcation of consumer spending.
