Key Takeaways:
The Iran war inflicted less damage on the US economy than feared, but its inflationary aftereffects are proving stubbornly persistent.
Economists have slashed the probability of a US recession this year to 15%, according to the latest Wall Street Journal survey, but the Iran war's inflationary imprint is forcing them to raise their inflation forecasts through 2027.
"The economy has shown remarkable resilience to the supply disruptions from the Strait of Hormuz closure, but the pass-through to core inflation is taking longer to fade than we initially projected," said James Okafor, macro analyst at Edgen.
The survey, conducted in early July, pegs the average probability of a recession within the next 12 months at 15%, down from 28% in the April survey before the US-Iran conflict erupted. Economists now see the consumer price index ending 2026 at 3.4%, up from the 2.9% they forecast three months ago, and expect the Fed's preferred core PCE gauge to remain above 3% through the first quarter of 2027.
The revision reflects a growing recognition that the war's impact on energy costs and supply chains is proving more durable than the direct hit to gross domestic product. The International Monetary Fund this month projected the US economy will grow 2.3% in 2026, unchanged from its April forecast and well above the sub-1% expansion many economists feared when the conflict began in late February. US jobless claims have remained near historic lows, dipping to 215,000 in the week ending July 4, while the June jobs report showed employers added 57,000 positions — less than half the prior month's total but still consistent with a labor market that is cooling rather than contracting.
Inflation's Stubborn Core
The persistence stems largely from energy costs that have yet to fully unwind. While Brent crude has retreated from its war-time peak above $100 a barrel to trade near $75, gasoline prices in the US averaged more than $4.50 a gallon in May — roughly 50% above prewar levels — and US drivers actually increased consumption in the second quarter, according to the International Energy Agency. Global oil demand is on track to decline by about 1 million barrels a day this year, the first annual drop since 2020, but the US has been the main exception.
Claudio Descalzi, chief executive officer of Italian state-controlled Eni, warned this week that the oil market risks breaking out of its current $80-to-$100 range by the first quarter of 2027 if the conflict continues, boosting inflation and reducing energy demand. The release of strategic stockpiles has helped contain prices so far, but Descalzi said global reserves are finite and the strategy carries growing risks. Every $5 increase in oil prices adds roughly $190 billion in annual costs to the global economy, according to Reuters calculations.
The Fed's rate-setting committee is deeply divided on the outlook. Minutes from the June meeting showed that half of the 18 policymakers who submitted projections supported lifting rates from the current 3.6% level by year-end, while the other half favored keeping them unchanged or reducing them. New Chair Kevin Warsh did not submit a forecast, reflecting his view that doing so can lock policymakers into a specific approach. The last time the Fed faced a comparable split was in 2016, when the committee was divided over the pace of normalization after the 2015 liftoff — a period that saw the S&P 500 oscillate in a 7% range for six months before the Fed delivered a single quarter-point hike in December.
What's at Stake for Markets
The lower recession probability is a positive signal for equities, but persistent inflation suggests the Fed may need to maintain higher interest rates for longer than markets had priced before the war. That dynamic creates a mixed macro environment: growth stocks and rate-sensitive sectors could face pressure from elevated bond yields, while energy producers and commodity-linked names benefit from the supply disruption. The S&P 500 has risen in four of the past five weeks, but the advance has been narrow, concentrated in energy and defense names rather than the broad-based rally that would signal genuine risk-on appetite.
The next test comes with the July consumer price index release on Aug. 13, which economists expect to show headline inflation holding near 3.2%. If the data surprises to the upside, the probability of a rate hike before year-end — currently priced at roughly 35% in fed funds futures — could rise sharply. If it cools, the door reopens for the half of the Fed that favors cuts, potentially reigniting the rotation into rate-sensitive sectors that stalled in the second quarter.
This article is for informational purposes only and does not constitute investment advice.
