The early months of 2026 are a good reminder that markets rarely move in a straight line. The year began with a constructive macro backdrop based on resilient economic growth, expanding fiscal policy and corporate fundamentals looking healthy. At the same time, uncertainty has crept higher, largely driven by geopolitical risks and the potential implications for inflation.
After a more stable period in the latter half of 2025, geopolitical issues have re-emerged as a key market driver in 2026. Escalating tensions and military actions in the Middle East have pushed energy prices higher and introduced the possibility of extended supply disruptions for oil, gas, fertilizer and certain chemicals.
Historically, oil shocks have transmitted quickly into broader macro conditions by raising input costs for businesses, squeezing consumers and complicating the job of central banks. While it’s too early to say if we are entering a sustained energy-driven inflation cycle, the risk has clearly risen.
Market pricing for near-term U.S. inflation expectations — as measured by inflation-protected U.S. Treasury securities and implied break-even rates versus nominal bonds — has risen dramatically since the beginning of the year. The two-year inflation break-even rate has jumped by nearly 1%, which is greater than last year’s run-up to the U.S. tariff policy announcements in April.
Central banks that were previously debating the pace of easing may now find themselves forced into a more cautious stance. That could mean monetary policies remaining tighter for longer than investors had anticipated only a few months ago. Expectations for rate cuts from the U.S. Federal Reserve have decreased, leaving no policy rate movement priced-in over the remainder of 2026.
At the same time, the economic picture remains surprisingly resilient. Fiscal policy continues to provide support to U.S. growth. And investment linked to new technologies — particularly AI — is helping sustain business spending.
Oil prices are likely to impact household budgets and provide some headwinds to growth overall, but the impact of oil at US$100 per barrel is not the same as it was in the past. Some forecasts suggest the U.S. economy could still approach 3% growth in 2026, reflecting its relative (to the past) energy independence, continued capital investment and productivity gains.
The underlying economic strength is showing up in corporate fundamentals as well. The most recent earnings season confirmed that balance sheets remain healthy, and profitability is holding up across many sectors. This combination of resilient U.S. growth and solid earnings explains why equity markets have remained relatively constructive despite the rising noise around geopolitics and inflation.
Set expectations
For investors, the challenge is that inflation does not need to surge dramatically to affect markets. For advisors, this environment reinforces the importance of setting expectations early — helping clients understand that periods of uncertainty are not anomalies, but a normal feature of long‑term investing.
Even modest upside surprises can alter expectations for monetary policy, interest rates and equity valuations. Markets have begun to price in more uncertainty, which is reflected in rising risk premia and option-implied volatility. If the disruption to the flow of oil continues well into the second quarter, the prospect of higher inflation and slowing global growth could become the dominant economic theme for much of the year.
Against this backdrop, a balanced portfolio stance remains the most sensible approach in the near term. Equities continue to benefit from solid corporate fundamentals and supportive economic growth. But elevated valuations in parts of the U.S. market, combined with macro uncertainty, argue against aggressive overweight positions. Taken together, this suggests maintaining a neutral allocation between equities and bonds.
Within equities, diversification across regions is becoming increasingly important. The U.S. market has delivered exceptional returns over the past decade, with the S&P 500 index’s total return gaining 321% versus the MSCI EAFE increasing 182%.
Despite international markets handily beating U.S. equities over the last year, valuation gaps remain wide, with the S&P 500 and MSCI EAFE price-earnings ratios at 24 and 17 respectively. For that reason, modestly increasing exposure to international equities relative to U.S. equities can help improve diversification and potentially capture opportunities linked to other regional growth trends.
A near-term risk worth noting is Europe’s potential growth — it could face much stiffer headwinds should imported energy supplies be constrained and prices remain high for a prolonged period.
Within fixed income portfolios, the focus should remain on high-quality corporate debt. Corporate balance sheets generally remain healthy, and investment-grade credit continues to offer attractive yields and safety. Maintaining a bias toward higher quality issuers helps provide resilience should economic conditions become more volatile.
There have been some concerns centred in private credit markets, particularly within the software-as-a-service sector as investors assess the competitive threat of generative AI to business models. As well, companies with weaker credit profiles have seen some spread widening over recent weeks, as investors seek liquidity and more compensation for credit risks.
While these areas may face some near-term challenges, the probability of a broader credit crunch spreading through the financial system remains low. Corporate credit spreads overall have only experienced modest widening year-to-date.
The global macro environment in early 2026 is defined by a familiar but complex combination: strong fundamentals alongside rising uncertainty. Economic growth remains resilient and corporate balance sheets are solid. Fiscal policy continues to provide support to economic growth. Yet geopolitical tensions, oil supply risks and the potential for renewed inflation pressure are introducing new volatility into the outlook.
For advisors and investors, this is not necessarily a reason to become defensive, but it is a reminder that diversification and balance remain powerful tools in managing risk.
Steve Locke is chief investment officer of fixed income and multi-asset strategies at Mackenzie Investments.