Q1 Shocks: Energy, Inflation, Growth?

Highlights: Q1 2026 Performance 

Equities 

The first quarter was eventful for markets. Stocks traded higher to start the year, with the S&P 500 posting a modest gain in January. However, the market traded lower in March due to escalating geopolitical tensions in the Middle East and the Strait of Hormuz closure, which led to a spike in oil prices. The S&P 500 returned -4.3%, but despite the late-quarter volatility, there were bright spots. The average S&P 500 stock outperformed the broad index by nearly +5% as market leadership broadened, and manufacturing data showed signs of improvement.  

Oil 

Oil prices rose in Q1 as geopolitical tensions escalated over the course of the quarter. In January, crude oil gained nearly +13% due to supply concerns related to Venezuelan output and Middle East tensions. Prices rose another +4% in February as geopolitical tensions continued to build, followed by a sharp escalation in March. The U.S.-Iran conflict and the closure of the Strait of Hormuz, a chokepoint for roughly 20% of global oil flows, sent crude oil prices surging nearly +50% in a single month. The price of oil rose more than +70% in Q1 with oil trading at the highest level since mid-2022.  

The combination of rising oil prices and the risk of renewed inflation pressure led to a shift in rate cut expectations. At the start of 2026, the market expected the Federal Reserve to cut rates two to three times by year end. However, the forecast changed as the market steadily priced out rate cuts during the quarter. Those rate cuts were completely removed by the end of the quarter, with the possibility of a rate hike being discussed as oil prices spiked in March.  

The situation remains fluid heading into Q2. As of quarter-end, the Strait of Hormuz is still closed, and negotiations are ongoing. Oil trades near $100 per barrel, an indication that the market expects the disruption to continue. The April and May inflation data will be among the first reports to capture the impact of higher energy prices, and the market will be searching for clarity around inflation outlook and interest rate policy. While the market waits for more data, headlines and developments in the Middle East will likely impact how stocks and bonds trade in early Q2. 

Credit 

The bond market also experienced a volatile quarter as Treasury yields reacted to the changing landscape. Figure 4 graphs the 10-year U.S. Treasury yield in Q1. Interest rates rose in January as the administration issued another round of tariff threats, while February and March were nearly mirroring images. Yields fell sharply in February as concerns about AI disruption caused stocks to trade lower, followed by a sharp reversal higher in March as oil prices spiked and the probability of rate cuts declined. The 10-year yield ended the quarter near 4.32%, the highest since June 2025, after briefly touching 4.45% in late March. The 2-year yield ended near 3.79%, up nearly +0.35%. The rise in shorter-term yields reflected the shift in rate cut expectations, as markets adjusted from pricing in rate cuts to the possibility that rates may remain at current levels for longer. 

Commentary for the Week Ending 4/3/2026 

Equities 

The S&P 500 returned 3.4% for the week as markets gained hope that the war may be close to an end. Markets rallied on a report that Iran may be willing to agree to a ceasefire based on certain guarantees; oil prices and treasury yields fell. Mid cap (+3.0%) and small cap (+3.3%) stocks gained as well. All sectors in the S&P 500 except for energy (-5.3%) had positive returns with communication services (+6.4%) and technology (+4.6%) leading. EAFE markets returned +3.0% with large gains in the U.K. (+4.8%) and Europe (+4.0%) while EM markets returned +0.3%. 

From a valuation perspective, only the S&P 500 trades at or above +1 standard deviation based on historical forward P/E ratios. For the next 12 months, EPS growth for S&P 500 is expected to be 16.9% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 36.0% (vs. 10.7% annualized over the last 20 years). Equities across markets caps in the U.S., and in non-U.S. developed and emerging markets, trade at or above their 20-year averages based on forward P/E ratios.  

Fixed Income 

Investment grade fixed income sectors had positive returns as rates fell across the curve. Municipals returned +0.7%, US AGG returned +0.7% and US IG returned +1.1%. HY bonds returned +1.2% as spread compressed 32bps while bank loans returned +0.1%. EM debt returned +0.8% even as the U.S. dollar fell 0.1% as spreads compressed 10bps. 

Rates 

Rates fell across the curve as the market eyed the end of the war and fall in oil prices. The recession-watch 3M-10Y spread compressed 10bps to +64. The 2Y-10Y spread compressed 2bps to +49. Rates fell in other developed markets as well. The BTP-Bund spread is at 0.86%. 5-year breakeven inflation expectations rose 4bps to 2.67% (vs. low of 1.88% on Sept 10, 2024); 10-year breakeven inflation expectations rose 5bps to 2.37% (vs. recent low of 2.03% on Sept 10, 2024); the 10Y real yield fell 14bps to 1.97%. For 2026, the market expects no cuts vs. the Fed’s guidance of 1 cut. At yearend 2026, the market expects the Fed Funds rate to be 3.63% vs. the Fed’s guidance of 3.25%-3.5%. 

Currencies/Commodities 

The dollar index fell 0.1%. The Japanese Yen remains at the psychologically and politically important 160 level. The commodities complex rose 4.5% as energy prices rose 6.6% for the week. Brent prices fell 3.1% to $109/bbl. U.S. natural gas prices fell 9.5% while European gas fell 7.4%; both remain volatile based on war-related headlines. Gold rose 4.1% to $4,677/oz, while silver rose 4.7% to $73/oz. Bitcoin rose 1.3% to $66,830.  

Market monitors 

Volatility fell for equities and bonds (VIX = 24, MOVE = 82); the 10-year average for each is VIX=18, MOVE = 80. Market sentiment (at midweek) was unchanged at -18, indicating that investors remain spooked by the war.