Ever since war broke out in Iran more than a month ago, our baseline outlook has been that the U.S. economy is a $31 trillion resilient beast that would absorb the energy shock and not fall into a recession.
That is what is happening. We expect a near-term resolution to the conflict, and the two-week ceasefire announced late Tuesday provides an opportunity for just that.
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Still, because of the magnitude of the energy shock, we are revising down our forecast for U.S. gross domestic product for 2026 from 2.4% to 1.7%.
Domestic businesses should anticipate that American households will prioritize spending on necessities like food and gasoline this year at the expense of discretionary items.
For example, staycations rather than vacations will most likely be the norm given the rise in the cost of airfares, lodging, travel and transportation.
Congress will most likely pass supplemental legislation to cover the costs of the war, but until that measure is in view, we do not think it will provide any near-term stimulus to cushion slower domestic spending.
We estimate that there is a 30% probability of a recession over the next 12 months, up from 20% before the war.
The impact of the war will result in slower growth, rising inflation and higher unemployment—a form of stagflation light that will permeate the economy for the remainder of the year.
We have modestly revised our forecast for unemployment to peak this year at 4.6%, and for inflation to peak at 4.5% in the consumer price index and 3.5% in the personal consumption expenditures index that the Federal Reserve uses to set policy.
Should the ceasefire hold, we think that there is a chance of a 25 basis-point cut in the federal funds policy rate at the Fed’s December meeting.
Should the labor market demonstrably weaken and push unemployment above our 4.6% peak, then we would expect the Fed to cut rates between 50 and 75 basis points in the second half of the year.
The Fed will exhibit patience and will remain on hold until at least its June meeting.
The magnitude of the shock, which resulted in a 38.3% increase in the price of West Texas Intermediate crude and a 39.6% jump in gasoline, will extract a price on domestic consumption, especially among working poor and working-class households.
Demand destruction started among those with lower incomes. But with the price per barrel of oil not reaching our threshold of $125 that triggers broad-based demand destruction, higher-income households will not be affected in the same way.
This limited demand destruction is why we revised down our GDP forecast from 2.4% to 1.7% and not lower.
Even with the ceasefire, though, we expect WTI crude to stay around $85 to $90 per barrel.
With that higher price, the fiscal tailwinds that we had anticipated before the war will be more than offset by the drag imposed on household outlays on energy, transportation and food.
There is risk to the upside on our inflation forecast. Should the ceasefire stick, though, I am not anticipating broad-based demand destruction nor am I forecasting any structural change to the American economy.
Ceasefire
The ceasefire is an unambiguously positive development. Oil prices plunged after the ceasefire was announced, and that will be followed by lower gasoline costs.
The ceasefire reduces the risk of a further rise in energy prices, which will ease inflation, reduce the impetus for rate hikes and lower the risk of recession if the ceasefire holds.
But it will take months for energy and other supply chains to return to anything resembling normal. Refined products like jet fuel, diesel and other chemicals will most likely take at least six months.
In terms of production, it will be years before natural gas returns to prewar levels. And until there is a full accounting of the damage to oil production and refinement facilities, we assume that the recent era of an oil surplus is no historic artifact.
An elevated risk premium will remain in energy and commodity prices. One reason is that ceasefire proposals that each side put forward contain clauses that the other side will find difficult to accept.
The long view
One of the most contentious proposals in the ceasefire is that Iran, perhaps with Oman, would issue a toll on shipping through the Strait of Hormuz, which would affect the petrodollar market that has been the economic underpinning on geopolitical security arrangements since 1973.
Should tolls be imposed on shipping in currencies other than the U.S. dollar, then one should anticipate a near-term depreciation in the greenback. In the first few hours following the announcement of the ceasefire, the U.S. dollar index declined by 1.1%.
The dollar is part of the foundation of American power, and a diminishment of that through economic, financial and security arrangements in the Gulf will shape postwar economics.
The takeaway
The war in Iran has led us to lower our forecast for GDP in the United States in 2026 to 1.7%, down from the 2.4% we had forecast at the beginning of the year. We expect inflation to peak at 3.5% in the policy-sensitive PCE price index and 4.5% in the CPI.
The announcement of the two-week ceasefire caused large declines in oil prices, which will drive down gasoline prices.
The ceasefire will help avert broad-based demand destruction that we expected would occur when WTI crude exceeded $125 per barrel.
