Stock and bond prices fell today as oil prices rose back to around $100 per barrel. The US and Israel continue to pound Iran from the air, but Iran's regime continues to launch missiles and drones at Gulf nations and vessels, and Israel too. The WSJ reported today that "Israeli officials assess Iran's ruling regime is unlikely to fall soon, as its rulers remain in control and conditions aren't ripe for an uprising." The stock market may be starting to discount the possibility that the war won't be short and that the Strait of Hormuz may remain effectively closed for some time.
The S&P 500 is now down 4.4% from its record high on January 27. The Nasdaq is down 6.4% from its record high on October 28. We are still expecting a 10%-15% correction in both. Adding to the stock market's woes are rising bond yields. The 10-year US Treasury bond yield bottomed at 3.95% on February 27, a day before the war started, and is at 4.26% this evening. The financial markets are starting to discount that the war might be stagflationary.
Let's briefly review the latest batch of US economic indicators, which are all pre-war:
(1) CPI. The bond market is starting to anticipate that the decline in inflation over the past couple of years, through February of this year, is about to be reversed by rising energy prices because of the war, rising food prices because of a shortage of fertilizer, and higher airfares as a result of more expensive jet fuel. Many other prices will also increase in the coming months because of the spike in oil prices. That's too bad because the CPI is almost down to the Fed's 2.0% inflation target (chart).
Excluding shelter, the CPI is up only 2.1% y/y (chart). The CPI's measure of rent of primary residence rose 3.2% y/y last month, well above the Zillow Rent Index (2.2%) and the ApartmentList Rent Index (-1.5%). That was the pre-war situation, which is no longer relevant.
(2) Unemployment claims. In the US labor market, weekly initial and continuing unemployment claims data still show that layoffs remain low and that the duration of unemployment may be declining (chart). On the other hand, continuing claims could be falling because long-term unemployment (beyond 27 weeks) isn't covered by the program.
(3) US federal budget deficit. On a 12-month-sum basis, federal government outlays totaled $7.07 trillion and federal revenues totaled $5.44 trillion through February (charts). So the federal budget deficit was $1.63 trillion over the 12 months through last month. Over the same period, the US Treasury raised $1.99 trillion in marketable securities.
Entitlement outlays rose to a record high of $3.66 trillion last month (chart). Defense and interest outlays totaled $930 billion and $1.0 trillion, respectively. President Donald Trump wants to raise the defense budget to $1.5 trillion next year.
Federal revenues were boosted by Trump's tariffs over the past year (chart). However, they will be lower over the next 12 months after SCOTUS ruled they are unconstitutional. Payroll taxes have flattened over the past year because payroll employment has flattened as well.
(4) Housing starts. The January housing starts report showed a headline jump that masked underlying weakness in the single-family sector. Overall, starts rose 7.2% m/m to 1.487 million units (saar) (chart). The headline gain was driven entirely by the volatile multi-family segment (5+ units), which surged 29.1% to an annual rate of 524,000. Single-family starts—the core of the housing market—fell 2.8% to 935,000 units. This decline was partially attributed to severe winter weather in the Northeast and Midwest, but also reflects ongoing affordability challenges.
(5) International trade in goods and services. The January US international trade report, released today, showed a massive narrowing of the trade gap, defying consensus. It is a significant reversal after the late-2025 volatility and provides a much stronger-than-expected start for Q1-2026 GDP tracking.
Total exports jumped 5.5% to an all-time high of $302.1 billion. The surge was led by a $14.6 billion increase in goods, specifically industrial supplies (nonmonetary gold/precious metals) and a record $66.9 billion in capital goods (computers and aircraft).
Imports edged down 0.7% to $356.6 billion. The decline was driven by lower demand for consumer goods—specifically pharmaceuticals—and a $2.8 billion drop in automotive vehicles and parts.
(6) GDPNow. Following today’s dual release of the housing starts and international trade data, the Atlanta Fed’s GDPNow model estimate for Q1-2026 real GDP growth jumped to 2.7%, up from 2.2% on March 11.
The war is the latest stress test of the economy's resilience. We think it will pass the test if the war ends in the next few weeks. But the risks of a recession will be increasing the longer the war persists.
(7) Sentiment. The Bull/Bear Ratios have been falling rapidly recently due to the war (chart). The stock market may be getting closer to the bottom from a contrarian perspective. The bottom will be made when the Strait is open again for safe passage. That may take a while longer and push the BBRs still lower for the next few weeks.
