Capital Ideas^™ 
Investment insights from Capital Group

Evolving geopolitical dynamics, largely driven by the U.S.-Iran war, plus upcoming U.S. midterm elections this fall, have forced investors to rethink their outlooks. Against this backdrop, our Capital Strategy Research (CSR) economists outline their U.S. views and take a deeper look at the key themes shaping the quarter.

Select macro views for the quarter: U.S. growth, inflation and productivity

The escalation in the Iran conflict has altered the near-term balance of risks for the U.S. macro outlook, reinforcing a stagflationary impulse even if hostilities do not intensify further. Energy prices remain the primary channel of these negative effects. Oil prices have risen sharply and, rather than fully retracing, may settle above pre-conflict levels. Historical sensitivities suggest that a sustained US$10 per barrel increase in oil prices typically subtracts 10 to 20 basis points from U.S. GDP growth, while adding only modestly to core inflation. However, the distribution of risks is asymmetric. Prolonged energy shocks tend to exert disproportionate downside pressure on growth and payroll dynamics.

Against this backdrop, the U.S. economy remains resilient but increasingly vulnerable. Under a scenario of extended disruption through the Strait of Hormuz, with Brent crude prices around US$100 per barrel, growth may slow toward the low 2% range in 2026, down from a pre-conflict baseline closer to 2.8%. A recession would still likely be avoided absent further escalation.

The labour market is the key swing factor. Payroll growth has stabilized, but geopolitical shocks historically tilt risk toward softer hiring and slower wage growth, raising the probability that consumer momentum could weaken if uncertainty persists.

U.S. inflation dynamics are comparatively less forgiving. Energy pass-through to headline inflation is immediate, and upstream price pressures are already evident, increasing the likelihood that inflation remains above target even as growth decelerates. In addition, disruption risk extends beyond energy. The Strait is a critical transit route for petrochemicals and industrial inputs, raising the possibility of more persistent cost pressures emerging in the second half of the year as higher chemical prices feed through to durable goods production and consumer prices.

Looking beyond near-term volatility and geopolitical shocks, however, the medium-term trajectory of U.S. growth increasingly hinges on productivity. The evolution of AI-driven efficiency gains may ultimately matter more for durability, inflation dynamics and potential growth than the current cyclical drag from energy and uncertainty.

As geopolitical uncertainty continues in 2026, we’re eyeing several themes this quarter, including AI’s continued productivity push, labour market weakness and how the U.S. Federal Reserve may view inflationary dynamics given higher energy prices.

Growth hinges on AI productivity gains despite conflict

U.S. productivity growth has reentered the discussion as a central driver of the medium-term economic outlook. Recent data points to a sustained reacceleration in nonfarm labour productivity, an outcome that has historically coincided with stronger and more durable periods of economic growth. Outside of recession recoveries, such episodes have tended to reflect structural shifts rather than late-cycle volatility, with important implications for both macro stability and market outcomes.

At a macro level, productivity represents an important driver of U.S. potential growth. The emerging view is that the economy may be experiencing an AI-centric, supply-side shock not yet fully reflected in market or policy assumptions. In this framework, productivity growth could move sustainably toward the higher end of historical experience — closer to 3% — rather than reverting to the lower post-Global Financial Crisis trend. That shift materially alters the inflation-growth trade-off. Higher productivity allows the economy to operate at a faster pace without reigniting inflationary pressures, keeping unit labour costs contained even as wage growth remains firm.

As a result, real GDP growth in the high 2% range appears plausible, despite ongoing demographic and labour market frictions. This productivity increase would have implications for markets and firms over time. By offsetting wage and input cost pressures, stronger productivity extends margin resilience and stabilizes cash flow generation when top-line momentum becomes less reliable.

Still, uncertainty remains around the timing and transmission of productivity gains. Although AI-related investment represents a clear upside risk to growth, the translation from capital deepening to broad-based efficiency gains and household income support is unlikely to be immediate or uniform. The macro payoff will ultimately depend on reinvestment and effective labour absorption.

Taken together, current productivity data suggests a higher medium-term economic speed limit — one that improves inflation dynamics, underpins earnings resilience and expands the end market opportunity set.

Labour market may remain weaker from AI labour shock

The U.S. labour market is showing resilience yet remains fragile. Firms are in early innings of implementing AI practices, and cost-rationing is ongoing. Hiring momentum has slowed materially, and job growth has at times hovered near zero, even as the unemployment rate has remained relatively contained.

AI’s impact on the labour market remains concentrated rather than systemic. While select industries including tech, advertising, marketing and call centres are experiencing disruption, broader labour conditions continue to show resilience. Wage growth has stabilized near 3.5%, labour force participation remains elevated, and aggregate hours worked have held steady, indicating that AI adoption has not yet translated into widespread job losses. To date, some effects of AI have been higher productivity and support for steady GDP growth, even as localized pockets of labour market softness emerge.

Against this backdrop, CSR sees a modest risk that unemployment drifts higher as slower hiring, AI-related labour disruption and tariff- and war-related margin pressure gradually outweigh supply-driven support to the labour market.

While it’s a touch soon to quantify the flip side of the equation, AI has the potential to bring job creation over time. The speed and scale of AI adoption make it imperative to monitor these developments closely and consider policy measures to mitigate potential labour disruptions.

Inflation to linger

U.S. inflation is expected to remain contained under the base case scenario, with core inflation around 2.5%, although upside risks persist. Energy price shocks from the war and fiscal policy developments represent sources of potential inflationary pressures. While energy prices do not directly feed into core inflation, sustained increases can still exert upward pressure on prices.

Even so, the Federal Reserve is likely to tolerate a temporary rise in headline inflation, particularly when it reflects supply-driven pressures rather than renewed strength in underlying demand or wage growth. At the same time, ongoing productivity improvements are expected to help curb longer term inflation pressures.

The U.S. economy can absorb oil prices near US$100 per barrel for a limited period without triggering a broader inflationary spiral. For investors, the key risk lies in how long elevated energy prices persist and how severe those increases become, as prolonged higher costs could eventually pose a more meaningful drag on growth.

Investor implications

Given the dynamic nature of the conflict, tariff policy and upcoming midterms, it is important for investors to maintain well-diversified global portfolios that focus on downside risk. While geopolitical and energy shocks are not unprecedented, each episode introduces distinct risks and transmission channels that can impact markets in different ways.

Over the longer term, the current environment appears more inflationary and is likely to drive higher capital spending, particularly among countries investing in infrastructure and energy security.