Cat: Hello, I'm Cat Von Alst, Client Service Director at SEI. I'm here with Client Portfolio Strategist, Art Patten, who will be presenting our economic outlook as of the first quarter of 2026. Conflict in the Middle East has dominated headlines toward the end of the quarter with the Strait of Hormuz effectively shut and the world's largest liquified natural gas plant extensively damaged. There's been a lot of talk about this leading to stagflationary conditions defined as higher inflation and weaker growth. What is SEI's view of the situation? Is stagflation on the way?
Art: Thanks, Cat, the situation in the Middle East has led many forecasters to update their predictions. They're now calling for higher headline inflation and possibly slower growth. For example, the Organization for Economic Cooperation and Development, or the OECD recently lowered its estimates for 2026 growth by 0.4% or more for the Euro area, South Korea and the UK, while raising inflation estimates meaningfully across the G20.
Cat: That doesn't sound good.
Art: No, it's not good. The combination of higher inflation and slower growth, which we refer to as stagflation, has the potential to hurt both stocks and bonds. It's also worth noting that the OECD's downside case projections, which assumed price shocks of $135 per barrel of crude oil and €77 per megawatt of natural gas are much starker with growth falling most significantly among Asian OECD members for at least two years, followed by Europe and then the Americas. Fortunately, this is just one of several possible outcomes, so it's important to keep in mind that it's just a bad to worst case scenario.
Cat: Now, are these higher inflation estimates just a reflection of higher expected energy prices, or do we expect prices to rise across the board?
Art: So the initial price increases will be driven by energy, energy derived commodities. Core inflation estimates, which exclude energy and food prices still remain fairly benign. However, we think these could also be subject to upward revisions if supply chain snarls persist for a meaningful period of time. On the other hand, if economic activity were to slow sharply enough, we could actually see downward pressure on prices at some point. And of course, if the Strait were to reopen soon, price pressures would start to subside as global supply chains began to disentangle.
Cat: In light of these higher inflation forecasts, how have expectations for interest rates changed from where we started the year?
Art: That's one of the more interesting economic and market developments to this point. Before the Middle East conflict started, most advanced economy central banks were expected to ease a bit further or remain on hold in 2026, but by late March, those rate cuts had been completely priced outta market expectations, and most central banks were expected to raise interest rates. After the recent volatility, markets once again expect the US Federal Reserve to either cut rates slightly or hold steady, but they're still pricing in the possibility of rate hikes from a number of other central banks.
Cat: Is this the right call given how uncertain things feel at the moment?
Art: It's really up for debate in this kind of global supply shock. The textbook approach, which we tend to agree with, would be to look through it since these things are really considered to be outside the reach of monetary policy. However, given the high inflation of the past decade, some central bankers seem dead set on keeping inflation expectations well anchored. We anticipate that central bankers are more likely to try to jawbone markets or to talk tough before taking any concrete policy actions, but we can't rule out rate hikes entirely. As Federal Reserve Chairman Jay Powell aptly put it at a recent press conference. We just don't know.
Cat: It sounds like central bankers are dealing with a great deal of uncertainty themselves, but do we have an idea whether they might be leaning toward interest rate hikes or cuts?
Art: It really depends on what happens to inflation expectations and whether markets begin to discount a global recession. Near term inflation expectations out to five years in the US, for example, are sending morning signals, but longer term expectations are actually starting to price in lower inflation. So as long as business, consumer and market expectations for inflation don't get out of hand, we would expect central banks to hold fairly steady. But if labor markets and the global economy were to start sputtering, we would then expect central banks to consider easing policies. However, central banks have committed policy errors in the past, so we shouldn't rule out rate hikes entirely at this point.
Cat: Thanks, Art, we appreciate your insights. SEI is focused on the major issues that are of interest to our clients. We incorporate these discussions into our advisory process as the impacts vary based on each client's goals. For more of SEI's insights, read our latest economic outlook available on our website.
