March 13, 2026

What started out as a relatively short-lived campaign to decapitate Iran’s leadership, dominate the sky, and eliminate Iran’s Navy, has turned into something that is likely to be a longer-lasting operation. Iran has successfully closed the Strait of Hormuz which may not be re-opened quickly. Crude oil prices have jumped to $95. The S&P 500 index has fallen about 5% from its peak. And bond yields have jumped 0.25% to 4.25%. Investors in all markets are understandably nervous. But what happens next? If oil prices remain at their current level for long the economic consequences will be far more pronounced with a bigger hit to GDP growth and a more pronounced increase in the inflation rate. But for what it is worth, traders expect crude prices to decline to $75 by yearend which would be very welcome if it occurs. While events in the Middle East are scary, it is important to remember that the economy is currently on solid ground with a great deal of help from a consumer that is still willing to spend and the rapid adoption of artificial intelligence which is boosting GDP growth and helping to keep inflation in check.

Consumers continue to hang in there. Consumer spending has increased 2.4% in the 12-month period ending in January. Consumer income has risen 1.8% in that same time period. But upper and middle income consumers are dipping into some of their stock market winnings to sustain a somewhat faster pace of spending.

The stock market has declined almost 5% from the record high level set at the end of January. Will that cause a significant cutback in consumer spending? We do not think so. A so-called “correction” in stock prices occurs when prices have fallen by 10%. Corrections are regarded as normal events in the course of an economic expansion. The stock market gets ahead of itself and then “corrects” for a short period of time before resuming its uptrend. Our sense is that this is probably what is happening currently. And remember that we are not there yet. Thus far the market has declined only about 5%. Will this significantly alter the pace of consumer spending? We do not think so. But if oil prices remain close to their current level for another month or two the damage will be more noticeable.

Investment spending is being supported by widespread spending on artificial intelligence. As we see it, firms are almost forced to spend money on AI. If they choose not to, the competition will. Those firms will take advantage of the opportunity to become more productive, boost their earnings, and grow rapidly. The firm that opts out will get lost in the dust. We expect such spending to grow at a steamy 8.5% pace this year.

The other thing worth noting is that net business formation is skyrocketing. AI has made launching a business easier and less costly. Those new firms will soon hire others. Consumers have become increasingly comfortable with e-platforms. The entrepreneurs starting these new firms are often workers who were displaced by AI. They are being driven by a combination of need and opportunity.

It is important to remember that the economy has some tailwinds which should provide it with some support in the event of a stock market “correction” — which has not yet occurred.

Everyone is also worried about an increase in the inflation rate. The increase in gas prices will boost the various inflation measures for a short period of time. But if the Fed sticks to its knitting and keeps money supply growth in check, the inflation rate will remain close to the Fed’s 2.0% target.

In 2020 as the economy collapsed the Fed significantly boosted the money supply and flooded the economy with liquidity to re-invigorate growth. At one point there was $4.0 trillion of surplus liquidity slopping around in the economy. Inflation accelerated. Because the Fed believed the increase in the inflation would be temporary it was slow to withdraw that surplus liquidity once the economy rebounded vigorously. The faster inflation rate became entrenched. Once the Fed finally recognized its policy error it began to shrink its balance sheet and eliminate the surplus liquidity. Only recently has it completed that process. Historically, the money supply has grown about 6.0%. In the past year money growth has been 4.3%. If that continues, money growth will soon fall below its long term trend line. That should pave the way for the inflation rate to eventually return to the Fed’s desired 2.0% path.

Oil prices may rise, but if the Fed controls the total size of the liquidity pie the prices of other goods and services should grow more slowly and inflation should remain near the 2.0% mark. Thus far investors do not appear to be too spooked by rising gas prices. The difference between the yield on the nominal 10-year note and its inflation-adjusted equivalent remains at 2.4% which is where it has been for the past several years.

Volatility in the markets is always unnerving. War dominates the headlines and it is impossible to know what either side might do next. But just keep in mind that the economy has some support which should allow it to perform surprisingly well in the months ahead.

Stephen Slifer
NumberNomics
Charleston, S.C.