RSM lowers its GDP forecast for 2026 to 1.7%

Ever since war broke out in Iran in late February, our baseline outlook has been that the U.S. economy is a $31 trillion resilient beast that would absorb the energy shock and not fall into a recession.

Still, because of the magnitude of the energy shock, we are lowering our forecast for U.S. gross domestic product for 2026 from 2.4% to 1.7%.

Domestic businesses should anticipate that American households will prioritize spending on necessities like food and gasoline this year at the expense of discretionary items.

For example, staycations rather than vacations will most likely be the norm given the rise in the cost of airfares, lodging, travel and transportation.

Congress will most likely pass supplemental legislation to cover the costs of the war—as of late April, that had not taken place—but until that measure is in view, we do not think it will provide any near-term stimulus to cushion slower domestic spending.

We estimate a 30% probability of a recession over the next 12 months, up from 20% before the war.

The impact of the war will result in slower growth, rising inflation and higher unemployment—a form of “stagflation light” that will permeate the economy for the remainder of the year.

We have modestly revised our forecast for unemployment to peak this year at 4.6%, and for inflation to peak at 4.5% in the consumer price index and 3.5% in the personal consumption expenditures price index, which the Federal Reserve uses to set policy.

Should the ceasefire hold, we think there is a chance of a 25-basis-point cut in the federal funds policy rate at the Fed’s December meeting.

Should the labor market demonstrably weaken and push unemployment above our 4.6% peak, we would expect the Fed to cut rates between 50 and 75 basis points in the second half of the year.

The Fed is expected to remain on hold until at least its June meeting.

The magnitude of the shock, which drove a 38.3% increase in the price of West Texas Intermediate crude and a 39.6% jump in gasoline, will weigh on domestic consumption, especially among working-poor and working-class households.

Demand destruction started among those with lower incomes. But with the price per barrel of oil not reaching our threshold of $125 that triggers broad-based demand destruction, higher-income households will not be affected in the same way.

This limited demand destruction is why we reduced our GDP forecast from 2.4% to 1.7% and not lower.

Should the ceasefire stick, we are neither anticipating broad-based demand destruction nor forecasting any structural change to the American economy.

Ceasefire

The reopening of the Strait of Hormuz and the ceasefire are unambiguously positive developments. Lower oil prices in the wake of the reopening were announced, with lower gasoline costs to follow.

The ceasefire, if it holds, reduces the risk of a further rise in energy prices, which will ease inflation, reduce the impetus for rate hikes and lower the risk of recession.

But it will take months for energy and other supply chains to return to anything resembling normal. Refined products like jet fuel, diesel and other chemicals will most likely take at least six months.

In terms of production, it will be years before natural gas returns to prewar levels. And until there is a full accounting of the damage to oil production and refinement facilities, we can assume that the recent oil surplus era is a thing of the past. 

An elevated risk premium will remain embedded in energy and commodity prices.