Resilience in a shifting macro landscape

Market recap

The first quarter of 2026 marked a shift to a more fragile macro regime, where softer growth, restrictive policy and renewed geopolitical risk challenged the earlier expectation of a smooth disinflationary path.

The first quarter of 2026 was defined by a challenging macroeconomic backdrop, as moderating growth, still-restrictive policy settings and renewed geopolitical risk combined to complicate the disinflation story. Across major developed markets, central banks remained cautious, with the European Central Bank (ECB), Bank of England (BoE) and the Federal Reserve (Fed) all leaving policy settings unchanged in March, even as activity softened and labour market conditions showed signs of gradual cooling.

The most important shift over the quarter was the re-emergence of an external inflation risk, driven by the escalation around Iran, which introduced a renewed energy and geopolitical shock into the outlook. 

That development added volatility across oil and broader markets, clouded the growth backdrop and made the path of further easing less predictable than headline disinflation alone had suggested.

For investors, the implication is that the late-cycle environment remains supportive of a cautious and selective stance, but one that now requires greater flexibility as macro visibility has become less clear. 

Policy rates remain restrictive in nominal terms, inflation progress has become less straightforward, and the Iran situation has reintroduced the risk that higher energy prices and tighter financial conditions could slow the disinflation process and delay the next phase of policy easing. 

In that context, in our view the emphasis should remain on resilience, quality and disciplined positioning, with greater conviction likely to depend on clearer evidence that the latest energy shock is not feeding into broader wage and price dynamics.

In the first quarter of 2026, the Eurozone macro backdrop remained distinctly late-cycle, with activity still expanding but lacking momentum, and inflation close enough to target to keep the ECB in a cautious holding pattern. As shown in Chart 2, both headline and underlying inflation have moved materially lower from the highs of the last cycle and are now much closer to price stability. The disinflation path, however, was not linear through quarter-end: Euro area headline inflation rose to 2.5% in March from 1.9% in February, largely because of higher energy prices, while services inflation eased to 3.2%, suggesting the latest upside move was driven more by external cost pressures than by a renewed broadening in domestic inflation.

Against the backdrop, the ECB kept policy unchanged in March, leaving the deposit facility rate at 2.00%, the main refinancing rate at 2.15%, and the marginal lending rate at 2.40%. The Governing Council (GC) maintained a meeting-by-meeting, data-dependent stance, while acknowledging that the geopolitical backdrop and higher energy prices had made the near-term inflation outlook more uncertain. The policy message was effectively one of patience: inflation expectations remain broadly anchored, but the threshold for further easing has risen as policymakers assess whether the energy shock proves temporary or begins to feed more meaningfully into core prices and wages.

Growth remained modest rather than recessionary. Eurostat’s latest dashboard shows euro area real gross domestic product (GDP) expanding by 0.2% in the fourth quarter of 2025, and the ECB’s March staff projections point to 0.9% growth in 2026, supported by firmer real incomes, resilient private sector balance sheets, and ongoing public spending on defence and infrastructure.

As Chart 3 suggests, the growth profile entering 2026 was uneven and low trend, not collapsing. Chart 4 tells a similar story in survey data, with the composite PMI holding in modest expansion territory while manufacturing has improved materially and moved closer to stabilization, even if it has yet to generate a broad-based industrial rebound. 

Labour market conditions continued to provide an important anchor. The Euro area unemployment rate stood at 6.2% in February, still low by historical standards, while ECB wage tracker data point to a further easing in negotiated wage growth through 2026. That combination should help limit second-round inflation risks, even as policymakers remain alert to any renewed pass-through from energy into services and compensation. 

For front-end markets, this leaves the ECB on hold for now, with carry supported by a still-restrictive policy setting, but with greater sensitivity to geopolitics, energy, and fiscal transmission than to any near-term upside surprise in growth. 

In the first quarter of 2026, the UK macro backdrop remained late cycle, with policy still restrictive, activity soft, and disinflation progressing only gradually. Chart 5 captures that mix well: inflation fell materially from the post pandemic peak, but it remains above target and wage growth is easing more slowly. Official data showed Consumer Prices Index (CPI) at 3.0% in February, with core CPI at 3.2% and services inflation still elevated at 4.3%, while regular pay growth slowed to 3.8% in the three months to January.

Against the above, the BoE left Bank Rate unchanged at 3.75% during the quarter. The February meeting still carried an easing bias, with a 5 to 4 vote to hold, but March delivered a unanimous pause as the Monetary Policy Committee (MPC) reassessed the inflation implications of the late quarter energy shock. The Committee continued to view policy as somewhat restrictive, while making clear that the next move will depend on whether renewed energy pressure proves temporary or feeds more durably into wage and price setting.

Growth remained subdued. The latest national accounts showed GDP expanding by just 0.1%, and the Bank judged underlying growth in the first quarter to be only around 0.1% to 0.2%. The survey backdrop was consistent with that low gear expansion.

As shown in Chart 6, services remained the relative outperformer, manufacturing hovered around stall speed, and construction stayed in contraction. March PMI readings reinforced that message, with the composite index at 50.3, services at 50.5, manufacturing at 51.0, and construction at 45.6. Chart 7 points to the same conclusion, growth has not rolled over, but it remains close to stall speed. 

Labour market conditions softened further at the margin rather than deteriorating abruptly. Unemployment rose to 5.2% in the three months to January, vacancies edged down to 721,000, and payrolled employment remained soft, all of which suggests slack is building gradually. That should help on domestically generated inflation over time, but the combination of still elevated services prices, only partial wage normalisation, and renewed energy uncertainty supports a cautious BoE stance. Fiscal policy also remained relevant for sterling rates. 

The March Economic and Fiscal Outlook described the forecast as little changed, but the fiscal backdrop as challenging, while the 2026 to 2027 Debt Management Office (DMO) remit pointed to £252.1 billion of gilt sales, including £12.0 billion of green gilt issuance. For cash and short duration investors, that keeps front end pricing sensitive not just to policy expectations, but also to supply, fiscal signalling, and near-term inflation volatility. 

In the first quarter of 2026, the U.S. backdrop remained late cycle, with growth still positive, the labour market gradually cooling, and disinflation continuing, albeit unevenly. As shown in Chart 9, the broad direction of travel in inflation has been lower, but the final leg back to target remains uneven and vulnerable to exogenous shocks. Headline CPI stood at 3.3% in March, with core CPI at 2.6%, while the Fed’s preferred Personal Consumption Expenditures (PCE) gauge was 2.8% year over year in February and core PCE was 3.0%. That combination gave policymakers greater confidence that inflation is no longer broadening, but not enough to declare that domestically generated price pressures have fully normalized.

Notably, the Fed kept the target range for the federal funds rate unchanged at 3.50% to 3.75% through the quarter and retained a meeting-by-meeting, risk-management approach. The March communication acknowledged that higher oil prices would lift near-term inflation and that risks to the labour market and inflation now run in opposite directions. Chart 10 reflects that more balanced stance: the policy rate was held steady, while the median March Summary of Economic Projections (SEP) pointed to 3.4% for year-end 2026, implying that any further easing is likely to be gradual rather than front-loaded. 

Activity remained resilient, but less broad-based than earlier in the cycle. Consumer spending was still expanding, with real PCE up 0.1% in February, and March payrolls increased by 178,000, but job creation remained low in trend terms and labour demand continued to soften. The unemployment rate held at 4.3%, average hourly earnings slowed to 3.5% year over year, and job openings were little changed at 6.9 million in February. For markets, that is consistent with a late-cycle slowdown rather than a sharp deterioration, enough to keep recession fears contained, but not strong enough to force a hawkish repricing at the front end. 

The Fed is no longer in an active easing phase, yet it is not preparing to re-tighten either. Instead, the focus has shifted to how long policy remains mildly restrictive, or close to neutral, while core services inflation grinds lower and the labour market cools further. That leaves front-end yields most sensitive to inflation surprises, labour-market slippage, and any evidence that energy or tariff-related price pressures are bleeding into broader inflation expectations.