We maintain our US growth forecast for 2026 at 2.2% but are watchful for rising stagflation risks. Our baseline continues to assume a degree of resilience in global growth, underpinned by several factors.

Selena Ling
Chief Economist & Head,
OCBC Group Research,
OCBC

1Q2026 market sentiment shifted sharply from optimism to risk aversion as the Iran conflict escalated into a full‑fledged energy supply shock. Disruptions to the Strait of Hormuz, which accounts for roughly one‑fifth of global oil flows, triggered a rapid repricing across asset classes. Oil prices surged above US$100, equities pulled back from their January highs, and volatility rose across bonds, FX, and commodities.

Thus far, the sell‑off appears to reflect an increase in geopolitical risk premium rather than a broad-based deterioration in earnings, even as markets begin to price in higher‑for‑longer inflation risks.

Looking ahead to 2Q2026, market direction will hinge critically on the duration and containment of the Iran conflict. A prolonged disruption to energy supply, compounded by damage to neighbouring infrastructure, has amplified stagflation concerns. Energy‑importing economies are particularly exposed. That said, history suggests geopolitical shocks tend to be transitory for markets, with underlying earnings resilience and policy responses providing a medium‑term anchor.

At present, market debate over whether the US Federal Reserve will hike or cut rates this year appears finely balanced. However, Fed Chair Powell’s observation that “energy shocks have tended to come and go pretty quickly” signals a preference for a wait‑and‑see approach for now.

Against this backdrop, Asian markets remain exposed to energy‑import shocks but benefit from relatively resilient domestic demand and a degree of policy flexibility. While many Asian central banks are reassessing their inflation outlooks, downward revisions to 2026 growth prospects have, thus far, been relatively modest.

Unlike the oil shocks of the 1970s, inflation today is starting from a lower base. In addition, strategic petroleum reserve releases have provided some near‑term relief, buying time, even if they cannot fully offset the impact of higher oil prices.

That said, ongoing disruptions to shipping and logistics, alongside rising costs in sectors such as LNG, petrochemicals, fertilisers, plastic packaging, and helium, point to challenging policy trade‑offs in the interim.

In an increasingly fragmented and volatile macro environment, investors should prioritise diversification, quality income, and inflation hedges, while remaining nimble to capitalise on market dislocations.

United States

We maintain our US growth forecast for 2026 at 2.2%, despite rising stagflation risks. Our baseline continues to assume a degree of resilience in global growth, underpinned by five key factors.

First, investment and production tied to artificial intelligence remain robust, providing an important structural tailwind. Second, effective US tariff rates have declined meaningfully following the Supreme Court ruling, easing trade-related cost pressures. Third, growth momentum from 2H2025 continues to carry into the current period. Fourth, fiscal and financial conditions remain broadly supportive. Fifth, the global business sector has repeatedly demonstrated its ability to adapt to geopolitical disruptions and supply-side shocks over recent years.

From here, the critical variable is the duration of the Middle East conflict. A swift de-escalation would still allow the economy to revert toward a soft-landing trajectory. However, if the conflict becomes protracted, the risk is a more entrenched stagflation dynamic, where inflation remains elevated, growth continues to weaken, and the Federal Reserve is left effectively paralysed.

Growth momentum softened noticeably toward the end of 2025. Fourth-quarter GDP growth was revised down to a modest 0.7%, while consumer spending was marked lower to 2.0%, a sharp deceleration from the 3.5% pace recorded in 3Q25. This weakness can largely be attributed to the government shutdown, which weighed on household activity.

Incoming data for 1Q26 has been more mixed. The labour market has begun to turn, with February payrolls contracting by 92,000, the clearest indication so far that underlying demand was already weakening even before the full effects of the energy shock had fed through.

Complicating the outlook, inflation has yet to fully cool. Core PCE inflation re-accelerated to 3.1% in January, ahead of the energy impulse, underscoring the persistence of underlying price pressures.

The Federal Reserve’s response reflects this tension. While the decision to hold rates at 3.50–3.75% at the 18 March FOMC meeting was widely anticipated, the widening dispersion in the dot plot continues to point to internal divisions over the appropriate policy path. Markets responded with a textbook repricing on stagflation fears, with equity indices lower and US Treasury yields moving higher.

Fed Chair Powell has emphasised that the Committee will look through the “short-term gyrations of the energy market,” reinforcing the Fed’s preference for patience amid a highly uncertain macro backdrop.

Over the past month, major central bank outlooks have undergone a notable hawkish repricing as energy prices have remained elevated. We continue to expect one 25bp cut in the Fed funds rate this year, pencilled in for 3Q26, although the risk of a further delay to this easing remains.

This forecast reflects a balanced assessment of competing forces — namely, near‑term inflation risks versus emerging softness in the US labour market and rising downside risks to growth. Should oil prices remain elevated for a more prolonged period, the drag through the growth channel is likely to become more apparent, partially offsetting inflation‑driven upward pressure on rates and bond yields.

We have previously revised our US Treasury yield forecasts modestly higher. We now expect the 10‑year yield to reach around 4.35% by end‑2Q26 before gradually easing to approximately 4.10% by year‑end (previously 3.95%). The 2‑year yield looks fairly valued at around 3.80% in the near term, with downside likely to materialise later in the year as expectations for the next rate cut draw closer.

Euro-Area

Incoming sentiment data across the euro area has been mixed. Economic confidence declined to 96.6 in March from 98.2 in February, while industrial confidence remained broadly unchanged. Consumer sentiment, however, weakened further over the month.

In response to the ongoing energy price crisis, EU officials are exploring coordinated policy measures. These are expected to focus on replenishing gas storage ahead of next winter, stabilising oil product markets, and ensuring the security of energy supplies. While the EU’s main oil and gas suppliers remain Norway and the United States, the region continues to be exposed to spillover risks from the Middle East.

Against this backdrop, ECB officials, including President Lagarde, have signalled a willingness to remain nimble and adjust the course of monetary policy should conditions warrant.

We revise down our 2026 GDP growth forecast to 0.9% from 1.1% and raise our headline CPI projection to an average of 2.5%, from 1.8%. These changes reflect the macroeconomic impact of the ongoing conflict in the Middle East on the euro area.

The transmission channels are primarily through higher oil and gas prices, as well as rising fertiliser costs, which are feeding through to food inflation. Against this backdrop, some ECB officials have begun to adopt a more vigilant stance toward emerging price pressures. For example, ECB Governing Council member Müller noted that “it’s probable that in the coming quarters interest rates will rise” should energy costs remain elevated for an extended period.

Consistent with this shift, the European Commission’s consumer survey shows a sharp increase in inflation expectations, with the one-year inflation gauge rising from 26.2 in February to 43.4.

Japan

The economy ended 2025 on a softer footing. Real GDP expanded by just 0.1% QoQ in 4Q25, undershooting the 0.4% market consensus and underscoring the fragility of domestic demand. That said, on a full-year basis, growth rebounded to 1.2% in 2025, following a 0.2% contraction in 2024.

Japan enters 2026 with improved political clarity, but macroeconomic uncertainty remains elevated. With Brent crude prices up sharply since early March, the lagged pass-through is likely to add around 0.5 percentage points to CPI over the next two quarters. As one of the world’s largest energy importers, Japan is facing a fresh and meaningful terms-of-trade shock from the surge in oil prices.

One encouraging development, however, is that real wages turned positive for the first time in 13 months. This provides some support for the view that inflation is gradually becoming more sustainable from a domestic demand perspective, rather than being driven purely by cost-push pressures.

Headline CPI eased to 1.3% YoY in February, while core‑core CPI, which excludes both fresh food and energy, held firm at 2.5%, remaining comfortably above the Bank of Japan’s target. The recent moderation in headline inflation appears driven largely by temporary factors, including policy support and favourable base effects. Government utility subsidies and more stable food prices have helped suppress headline inflation for now. However, the escalation of the Iran war is likely to reverse part of this relief through renewed energy price pass‑through.

Against this backdrop, the BOJ voted 8‑1 to keep the policy rate unchanged at 0.75%. The March Summary of Opinions, released on 30 March, struck a distinctly hawkish tone. Several board members highlighted the need for further rate hikes, with one even raising the possibility of accelerating the pace of tightening. Governor Ueda also acknowledged that exchange‑rate movements can influence underlying inflation via their impact on inflation expectations, an important signal amid recent yen weakness.

The 27–28 April BOJ meeting is therefore a live one. We expect the Board to revise its inflation forecasts higher and potentially adjust its policy language, keeping the prospect of a near‑term rate hike firmly on the table.

China

China has lowered its 2026 GDP growth target from “around 5%” to a range of 4.5%–5%. The lower bound of 4.5% can be interpreted as the minimum growth rate required during the 15th Five‑Year Plan period (2026–2030) to keep the economy broadly on track to achieve the 2035 objective of doubling per‑capita GDP relative to 2020.

We maintain our 2026 growth forecast at 4.7% for now, despite the escalation of the Iran war. China’s producer price index (PPI) basket has a heavy weighting in sectors such as raw‑materials processing and chemical manufacturing, where crude oil is a critical upstream input. Historically, crude oil prices have shown one of the strongest correlations with China’s PPI among major macro variables.

As oil prices rise, upstream producer prices tend to respond quickly. As a result, the recent surge in crude prices could help push China’s PPI, and subsequently the GDP deflator, back into positive territory sooner than previously anticipated.

One of the key highlights of this year’s Government Work Report is the introduction of a comprehensive fiscal‑financial coordination package aimed at boosting domestic demand. As part of this initiative, authorities have set up a RMB100 billion special fund to support demand expansion through a coordinated mix of fiscal and financial policy tools. The programme is designed to combine interest subsidies, financing guarantees, and risk‑sharing mechanisms to ease credit constraints and encourage greater private‑sector participation in domestic‑demand‑related activities.

Overall, China’s fiscal impulse appears broadly stable and came in slightly below market expectations. The broad fiscal deficit ratio is estimated at 8.1%, representing a decline of 0.3 percentage points from last year.

Interestingly, the escalation of the Iran war could also provide an unexpected tailwind to China’s reflation efforts, particularly via its impact on upstream prices and producer inflation.

China’s equity market came under pressure amid the escalating US-Iran conflict. Unlike developed markets where government bond yields have surged amid rising stagflation concerns, China’s bond market outperformed, supported by renewed flight-to-safety demand. The 10-year government bond yield fell in the last week of March. The recent surge in oil prices may delay market expectations for further rate cuts in China, but easing is still not off the table. In our view, China’s relatively lower sensitivity to the recent oil shocks, underpinned by structural factors, continues to provide greater flexibility compared to its regional peers. We keep our 10bps rate cut unchanged, though the timing is likely to be pushed back to 2H2026.