Monologue
The meta-theme of this week's note is that markets move first, then politics, then the fundamental macro, but the causality flows via expectations in the opposite direction.
Markets have rallied this week as both US and Iranian authorities hinted that they were moving toward a ceasefire extension deal that would include reopening the Strait of Hormuz. Despite the sense that a deal could be announced at any moment, Bloomberg's top two headlines early Sunday morning do not inspire confidence: "US Says Deals With Iran for Safe Hormuz Transit Are Prohibited" and "Israel Expands Ground Operations in Lebanon, Deepening Incursion."
Perhaps this is the week. We've been caught out by false dawns in the Iran conflict a few times before. We initially underestimated the extent of America and Israel's engagement, and since then, more than one Monologue has been rewritten after a Friday "peace" announcement has fallen apart or been denied by the other side, come Sunday.
Meanwhile, the inflation outlook is deteriorating with every day that the Strait of Hormuz remains closed, turning a one-off oil price shock into an inflationary catalyst that has reversed the trajectory of interest rates and asset prices (public equities excluded — the S&P 500 just recorded its longest weekly win streak since 2023).
As we approach a new phase of the conflict (agonizingly slowly), my concern is that markets will be overly optimistic about the meaning of an extended ceasefire, and walk pricing and interest rate expectations back to February levels. This would be setting themselves up to get caught out when the fragility of Gulf shipping becomes clear, or when core inflation continues to rise despite a ceasefire holding.
Below are the questions that I think need to be answered before we can update our views on the near-term and medium-term outlook. Until a deal is announced, we only have partial answers to most of them.
For that reason, we're not adjusting the probabilities across our macro scenarios just yet. It would be a good thing if we could revisit these questions next week with more concrete responses.
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Q: How open is the Strait under the extended ceasefire? Are there conditions or fees for transit, and who is enforcing them?
A: Not enough information to assess
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Q: How robust is the agreement to open the Strait? Does it depend on any conditions or thresholds? Are there any obvious catalysts for closure? What's to stop Iran from leveraging its strategic control of the Strait to force concessions in the lead-up to US midterm elections?
A: Not enough detail to assess
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Q: How does the agreement shift related geopolitical dynamics? How does China play in the calculus of the extended ceasefire, and will it influence future dynamics?
A: China will welcome a deal, which would come just in time to prevent major shortages at refineries that depend on Iranian crude. Pressure on the Iran-China relationship is the pain the US blockade was designed to inflame. However, the reopening buys Iran space for another closure of a similar duration down the line once Chinese storage is replenished.
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Q: Have oil markets reacted appropriately? In light of the questions above, is a meaningful risk premium built into the oil price?
A: Brent crude fell to $91 per barrel this week in anticipation of a deal. At just $20 (~30%) higher than the pre-war level, this already looks close to a fair price given the risk premium required by the questions above, and the lingering global demand to rebuild and increase inventory. A move below $85 would be overdone.
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Q: Do we understand the inflation process once the Strait reopens?
A: Lower oil prices would generate a mechanical reduction in energy prices with a few weeks' lag in most countries, reducing headline inflation. For food and manufactured goods negatively impacted by urea and plastics price surges, price pressures may last several more months as supplies are shipped to their end users. We don't know if higher costs incurred by companies (already evident in the PPI data) will be passed on, absorbed, or discounted back to the consumer (prices are famously "sticky downwards"), making near-term core inflation dynamics uncertain. Beyond Iran, there are reasons to believe that underlying US inflation is trending up, including upward-drifting expectations, AI-related investment demand, delayed tariff pass-through, and the immigration-starved labor market.
A fragile deal, combined with markets overly dovish on inflation and interest rates, would set us up for an inflation spike and overheated conditions down the line. Fixed income would be the loser from this kind of setup, and public equities would experience some volatility. But in the short run, it's not a bad setup for everyone. It describes exactly the setup for M&A momentum that private equity has been hoping for.
Don't forget, too, that not everyone is a loser from higher energy prices. Canada is one country that's probably benefiting in net terms from the energy price shock, given its low underlying inflation and political pivot toward its neglected resources sector.
In this week's Memo, we ask whether the Carney government's big infrastructure and mining drive is an investable theme — read on.
With that, enjoy this week's update.
Dylan Smith
Founder and Chief Economist
Marginal Movers
Rising 👆
- Interest rates (for commodity exporters): How Should Central Banks Respond to Commodity Price Shocks? Optimal Monetary and Exchange Rate Frameworks for Commodity-Exposed Economies — "Stabilizing domestic prices is welfare-optimal for commodity exporters, in line with standard open-economy policy prescriptions. But for economies that use commodities as inputs in production, optimal policy largely ‘looks through’ the direct and indirect effects of commodity shocks on domestic prices."
- Productivity: Have We Entered an Era of High Productivity Growth? — "recent patterns resemble the mixed signals during the early stages of the 1990s productivity surge before a sustained high-growth period materialized, giving reason for cautious optimism about future productivity growth."
Falling 👇
- AI profits: Is AI profitable? dotcom — "Tracking the spend and revenue of frontier AI companies (May 2026)."
- AI deflation: AI’s Macroeconomic Challenges and Promises — "AI, a technology with the potential to make the economy more productive, is, for now, absorbing resources faster than it is generating returns."
Macro Monitor
Has US consumer spending topped out?
The short answer is "maybe", but we don't expect consumption to fall off a cliff imminently either.
With a potential reopening of the Strait of Hormuz shifting attention away from the inflation outlook (rightly or wrongly), the health of the US consumer is emerging as a key developing theme. Robust, if unspectacular, consumer spending has underpinned growth for several years, but tailwinds may be turning into headwinds.
There was a lode of data out this week that helped build our understanding of the issue, but it was riddled with a cross-hatch of conflicting signals and conclusions.
The starkest data point of the week was the continued rise in 90-day credit card and auto loan delinquencies, which are hitting pre-GFC levels. Clearly, life is not getting any easier for people on the lower end of the income distribution. For these consumers, the fact that inflation is now eating into wage growth will not help matters.
Commentary in earnings calls from consumer-facing business executives over the past couple of weeks confirms this: Walmart's CFO said that low-income Americans are “more budget conscious" and "navigating financial distress.” But retailer after retailer has also pointed out that the top decile of the income distribution is spending so freely that the aggregate numbers are holding up just fine. The same Walmart CFO said that the wealthier Americans are “spending with confidence.”
A cross-check with any high-frequency spending data corroborates that view, and it's reflected in the fact that aggregate personal consumption expenditures (PCE) rose in April, even after adjusting for inflation.
Another major entry on the positive side of the ledger is that labor markets have gradually but unambiguously improved through the course of 2026.
One reason consumers have been able to continue spending freely despite paying higher prices at the pump is that Uncle Sam has boosted their incomes. Tax rebates from the One Big Beautiful Bill Act have hit wallets and supported consumption. This effect will fade in the coming months, and if prices continue to rise rapidly, we would expect to see real spending adjust downwards.
So, perhaps consumption growth is peaking, but there is enough momentum in the economy to keep it in positive territory overall. There is one important thought that those worrying about a recession should keep in mind: downturns almost always start with a collapse in investment and corporate spending, which then trickles down to consumers via earnings and labor market deterioration. Corporate earnings are in fine fettle, and we're in the early phases of a generational capex cycle, so a softer consumer would not be terminal for the economy.
Canadian recess
Canada entered a "technical recession" in Q1 of 2026, with the economy contracting by 0.1%, following a 1.0% decline in the final quarter of 2025 (both annualized). It's worth noting that the drop in GDP in Q1 was so slight that the recession may be revised away in subsequent estimates.
The reason for the economic stall is not hard to identify. Business investment declined outright for the fifth quarter running as trade uncertainty paralyzed businesses. A surge in inventory investment in March was offset by higher imports.
We see the GDP data as something of a lagging indicator. Some trade uncertainty will clear up over the summer, although just how much depends on whether the USMCA/CUSMA is renewed on updated terms, or the trade relationship review is kicked down the road by another year. StatsCan's advance estimate of GDP for the month of April was a healthy 0.4%. As we discuss in the Memo below, the investment environment in Canada is improving; it only needs a catalyst in the form of improved trade certainty to get moving.
See the appendix for arcMacro proprietary Factors and the Key Macroeconomic Indicators tracking chart.
Market Monitor
The "ceasefire trade" shaped macro markets this week.
The price of WTI crude oil fell by $9.2 to $87.4 per barrel (its lowest weekly close since March 17th) on optimism that supplies will soon begin to transit the Strait of Hormuz. Oil and gold continue to move in opposite directions. Lower interest rates and a weaker US dollar more than offset the "risk-on" headwind to gold prices, which rose by $40 to $4,546 per ounce. We have maintained throughout the conflict that a peace deal would catalyze a recovery in gold prices back towards the $5,000 per ounce mark.
Sovereign bonds finally had a week to cheer about. Yields fell, with the front end dropping by more than the back end to steepen the curve. The action was more pronounced in the US than elsewhere; the 2-year Treasury Note yield is back below 4%, though still more than half a percentage point higher than it was three months ago. This reflects markets' updated assessment of the interest rate outlook: No hikes by the end of 2026 is again the base case in futures markets (priced at 51.5%, according to CME Group, with the balance for one or more hikes). Fed officials signaled in speeches this week that they remain in "wait and see" mode, but with incoming Chair Kevin Warsh yet to speak publicly on the outlook, their views are being taken with a pinch of salt.
Despite the good news in sovereign markets, corporate spreads widened (A-rated credit by 4 basis points, BBB-rated credit by 2.2). New data on rising delinquencies likely contributed to the widening.
Finally, equities powered ahead again, with only Hong Kong's Hang Seng and the UK's FTSE 100 losing ground this week. With a 1.4% gain, the S&P 500 inked its longest weekly winning streak since 2023 (9 weeks), during which time it has surged by 16% and the Nasdaq Composite by 25%. That would probably have been the case without ceasefire talks, so strong is the tailwind from earnings strength and the AI capex cycle.
Even that achievement was outshone by the MSCI emerging markets index, which jumped by 4% on the hopes that energy-importing countries are through the worst of the Iran shock.
See the appendix for the market monitor table
Memo
Investing in the Carney agenda, one year in
Bottom line: Economic conditions move more slowly than politics. Canada's economic data is still reflecting Trudeau-era decisions. However, the Carney government is radically shifting Canada's long-term outlook as it gets to work on the challenge of raising productive investment. We outline how to position a portfolio to capitalize on the long-term effects of the Carney government.
What it means for investors: If you have a long investment horizon, then positioning for the Carney era means going long on energy, minerals, construction and engineering, and aerospace and defense. In fixed income, it means keeping duration low. And institutional investors would do well to channel their new private markets allocations to infrastructure and private equity directly tied to the Carney government's programs.
It's 2016, and the Trudeau government has been in power for a year. The "sunny ways" agenda is taking shape: climate and social issues are front and center, and the legalization of marijuana is around the corner. Indulging in that particular theme will have to wait; your task is to craft a portfolio for the Trudeau decade.
You start by investing in real estate, and overweight your stock portfolio in favor of REITs and construction & materials companies. You double down on the mortgage boom by buying domestic banks, and add a healthy serving of renewable energy producers to the mix. This comes at the expense of oil & gas and mining & minerals stocks, which you underweight heavily. Expecting Canada's relative long-term economic prospects to weaken, you invest more in US equities, short the loonie, and tilt your fixed income allocations to long-term Government of Canada bonds (this part breaks down after COVID). Congratulations, you have won the Trudeau era.
Ten years later, running the same exercise a year into the Carney government (without the benefit of hindsight), you would probably construct almost a perfect mirror image of the Trudeau portfolio.
Prime Minister Carney has centered his government around a single agenda: raising productive investment to kickstart growth and restore lost prosperity. This is the common thread running through his much-vaunted international economic diplomacy, his positioning in trade negotiations with the Trump administration, his support for the oil & gas and mineral sectors, his mooted public wealth fund, and the recent announcement of investment in skilled trades development. Even the boost in Canada's military capacity has an underlying domestic investment logic to it.
The starting point for Carney is challenging. Canada's economy is still wearing the hangover of decisions made in the latter years of the Trudeau government and is feeling the chilling effects of a cold trade war with the United States. The Trudeau era fiscal expansion – which the Carney cabinet has so far made no effort to arrest – has raised the term premium and steepened the yield curve, creating a challenging funding landscape for long-term investment projects. Meanwhile, trade negotiations with the US have stalled ahead of the review of the USMCA/CUSMA deal that has shielded Canada from the worst of President Trump's tariffs.
Both of these factors are depressing business investment. Companies need greater certainty before committing to new expansion plans, especially in a higher-rate environment. This investment freeze has tipped Canada into a technical recession as of Q1 2026, when the economy recorded a second consecutive quarter of negative growth.
If you squint hard, you'll see some green shoots budding. Despite the downturn, the economy has held up better than many expected, especially considering the negative impact of tighter immigration policy. The economic story the Carney government is selling has international supporters — net direct investment in Canada turned positive for the first time in a decade in 2025.
So, how would we position a portfolio to outperform in the Carney era? We would start by acknowledging that, just as Canada's economy is still performing on the basis of Trudeau-era decisions, investing on the back of policy and politics is a (very) long game. This is a 10-year allocation exercise.
Public equities are the easiest place to position: just reverse the Trudeau portfolio weights. We would be overweight on the following sectors: energy, mining and minerals, heavy construction and engineering, and aerospace and defense. We would underweight real estate and other rate-sensitive sectors. These are not new ideas. A "Carney index" of the above-mentioned industries has outperformed the TSX benchmark by 16 percentage points since Carney took office, up by 56%. Still, there is enough implementation risk hanging over Carney's major initiatives to believe that this outperformance can extend significantly over time.
In many ways, private markets are best-positioned to maximize the Prime Minister's investment push. Infrastructure funds are an obvious place to start, but mid-market private equity funds making smart bets on the energy and defense value chains are likely to perform well, too. New fundraising rounds for private funds with this focus offer large institutional investors a chance to diversify their private-market risk, which is currently highly concentrated in tech and data centers within existing funds.
In fixed income, we'd stay short. It's becoming clear that efforts to catalyze investment will not come cheap, with industry demanding the Federal Government put some money where its mouth is on major projects. The Carney government has so far limited cost-cutting to a measured trimming of the bloated civil service. There is no sense that major program cuts are in the offing. This means that, while Canada has one of the best fiscal profiles among its G7 peers, it will not be able to shed its fiscal term premium. What's more, higher investment is itself a (positive) factor behind higher long-term rates, especially if a productivity windfall is expected (because returns on capital are higher, and savings fall relative to investment demand). Plus, in the near-term, we see Canada as being less exposed to the Iran inflation shock than its peers, meaning rates can stay lower and bond prices higher than Treasuries. We'd keep our Canadian bond duration low.
There is no direct "Carney trade" in commodities or currencies. Decades of economic research have found that exchange rates can't be forecast systematically over medium- to long-term horizons, so we won't try. At this horizon, the best advice is to hedge exchange rate risk. And Canada alone does not drive global commodity prices, so direct commodity investments are not in scope.
Generating a fresh capex cycle is a large and challenging task, with benefits that are likely to accrue only after the Prime Minister leaves office. Trade tensions with the US are not helping kickstart the process. But from an investing standpoint, they're creating time to position for the long term. When trade uncertainty is resolved or at least significantly reduced, the cycle can begin in earnest.
Appendix
Proprietary Factor and Regime Model and Key Indicators
Disclosures
AI Declaration
All written content, analysis, and opinions are original and ascribed to the author. AI tools were used for proofreading and summarization purposes only. AI tools may also have been used in the development (codebase) of the analytical models reported in this document.
Disclaimer
This publication is for informational and educational purposes only and does not constitute financial or investment advice. Nothing in this report should be construed as a recommendation to buy, sell, or hold any security or financial instrument. Always consult a qualified financial advisor before making investment decisions.