US manages through limited job growth and rising price pressures

Listen to this article

Economic growth has decelerated since the 4.4% increase in real Gross Domestic Product we saw in the third quarter of 2025.  For the fourth quarter of 2025, real GDP grew by only 0.5%, bringing real GDP growth for 2025 to 2.1%.  Government spending was the biggest detractor for the fourth quarter, pulling real GDP down a full percentage point, a result of the government shutdown.  Net exports were also a slight detractor as trading volumes remained volatile.  Ignoring the more volatile categories of late, consumer spending and private investment increased 1.8%, a sign that the US economy remains resilient.  Forecasts for first quarter real GDP are 1.2% according to the Atlanta Federal Reserve.  Consumer spending and private investment are again expected to be the biggest contributors to growth.

Understanding Iran War implications

The Iran conflict has increased geopolitical tensions, which in turn has sent equity, interest rate, and commodity volatility soaring.  The Strait of Hormuz, responsible for carrying 20% of the world’s daily oil and natural gas consumption, has been essentially shut down since the onset of the war.   Oil prices reacted violently at the start of the war on February 28, with prices increasing by more than 65% through the end of the quarter as global supply came under pressure.  Oil prices have settled from recent highs, though they remain nearly 50% higher than at the onset of the war.  In addition to oil and natural gas, the Strait of Hormuz is also responsible for a third of global fertilizer transport, with fertilizer being a key input for food prices.  Despite the positive headlines as of this writing we have yet to see transport resume in the Strait of Hormuz.  Should the Strait remain closed, we can expect continued volatility in energy, fertilizer, and shipping prices.

The Iran conflict potentially paints a different inflation picture.  When prices for necessities like food and energy increase because of a supply constraint, consumers often reduce spending in other categories.   Inflation reflected this dynamic in March, with headline Consumer Price Index (CPI) increasing by 0.9% for the month and an increase of 3.3% over the last 12 months.  The biggest driver of the monthly price increase was energy prices, led by gasoline, which was up more than 21% and accounted for nearly three quarters of the monthly increase.

A view on a complex employment and rate environment

The unemployment rate ended the quarter at 4.3%, down from 4.4% in December 2025.  Despite the appearance of a smooth quarter, job growth was very volatile.  January saw 160,000 jobs created, followed by a loss of 133,000 jobs in February, and another gain of 178,000 jobs in March.  Zooming out, the economy has added almost zero jobs over the last 6 months.  This is down sharply from prior years where the economy saw monthly job growth averaging well over 100,000 jobs per month.  While this may seem like a concern, it is not necessarily a negative for the unemployment rate given the lack of growth in the labor force.  According to the San Francisco Federal Reserve, today’s immigration policy, life cycle of baby boomers, falling birth rates, and changes in labor force participation have slowed the growth in the labor force to 0.4% annually.  While zero monthly job growth would typically send off alarm bells, the San Francisco Fed estimates that zero growth is currently the breakeven level for the unemployment rate to remain unchanged.

The recent rise in inflation has not made the Federal Reserve’s (the Fed) job easier.  At the start of the year, the Fed was walking a tightrope between raising rates due to inflation remaining above their 2% target and lowering rates as monthly job growth has slowed over the last year.  Prior to the Iran conflict, rate markets were forecasting between 50 and 75 basis points worth of rate cuts for 2026.  Today, the market is expecting zero rate cuts as inflation has moved further from the Fed’s target.  Long-term rates have responded in kind as well, with the 10-year treasury rate increasing by more than 20 basis points since the beginning of the year and increasing by more than 30 basis points since the start of the conflict.  Interest rates tend to increase with inflation expectations.  The Fed faces a tricky situation. The recent jump in inflation was driven largely by higher energy prices caused by supply problems. The key question now is whether those higher energy costs will spill over into other parts of the economy, slowing growth and reducing consumer spending.

Market updates

The S&P 500 Index was down 4.3% for the quarter after being close to an all-time high shortly before the war started. Small cap stocks managed slightly positive returns and outperformed large caps despite giving back much of their lead in the wake of the escalation of geopolitical risks and associated pullback in risk appetite. One market trend that was essentially uninterrupted for the quarter was the steady and consistent underperformance of Growth vs. Value stocks. Growth was down almost double digits, while Value was significantly positive. This reflects not only ongoing skepticism about the scale of AI‑related spending by some of the largest technology and tech‑adjacent companies but also growing concerns about how AI could disrupt existing business models. The software industry has been one of the clearest examples. In several cases, companies saw sharp declines after Anthropic announced new AI tools, prompting investors to question whether these firms’ competitive advantages would remain durable in a rapidly changing landscape.

These types of underlying market currents can also be seen in the relative performance across sectors. Technology and Communication Services were among the worst performing sectors.  Consumer Discretionary and Financials also performed poorly in the wake of higher oil prices, which has impacts on consumers and most businesses. The flipside of this dynamic was the massive outperformance of Energy, which was up almost 40% for the quarter.

Differences in performance across global markets also reflect varying levels of reliance on upstream supplies affected by the closure of the Strait of Hormuz. International markets outperformed U.S. markets, even though the U.S. economy is a net energy exporter.  Emerging Markets managed to outperform their Developed Market counterparts, posting only slightly negative returns despite their historical sensitivity to ebbs in risk appetite and reliance on energy and commodities currently tied up in transit.

Bonds are often viewed as a safe haven when geopolitical tensions rise and investors pull back from risk. This time, however, bonds offered little protection, because the primary channel through which geopolitical risk is affecting markets is higher oil prices. Because energy sits at the foundation of nearly all economic activity, rising oil costs raise the risk of renewed inflation rather than providing the usual support for bonds.  The Bloomberg Aggregate Index was down 0.05% for the quarter as intermediate and long-term rates rose modestly. The Bloomberg High Yield Index was down slightly more, falling 0.5% in the quarter, with credit spreads widening as risk appetite decreased.

Conclusion

Geopolitical events remain in flux, as does the market’s understanding of the implications of the AI transition.  There is very little clarity on how the war will play out, whether the ceasefire will hold, or whether hostilities will reemerge.   However, there are reasons for optimism, and relatively supportive fundamentals remain intact.  For now, inflation remains at relatively contained levels, the fiscal loosening from the effects of the One Big Beautiful Bill should offset some of the pain from higher energy prices, and AI and related infrastructure spending should support growth.  Moreover, history has shown that most geopolitical events are associated with strong market recoveries roughly 6-12 months down the road.  The extent to which the war becomes a serious issue for economic growth or for inflation will be a function of how long it lasts, and how long energy prices remain elevated before being passed through the supply chain. In the absence of clarity, diversification and discipline are investors’ best bet.

Matt Kelley is Chief Investment Officer, Cooper/Haims Advisors, an ESL company. In his role, Matt is responsible for institutional account portfolio management and oversees the portfolio strategy team, while supporting the broader ESL wealth entities.

Contributions also offered from Scott Shattuck, Senior Portfolio Analyst, Cooper/Haims Advisors.

The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed.