By Daleep Singh, Vice Chair and Chief Global Economist at PGIM
Overheating: The Collision of Two Eras
My base case for the U.S. economy is now overheating. We are watching “old school” supply shocks—oil, tariffs, labor constraints—collide with a 2030s-style demand engine powered by AI. Until AI capex translates into a productivity dividend—which we believe is still at least a year away from being disinflationary—the two forces are not offsetting. They are compounding, producing sticky high inflation above 3%, very high nominal growth above 6%, higher long-term interest rates, steeper yield curves, and ongoing depreciation of the dollar.
The “Hydra Holdout” scenario —a decentralized Iranian regime hunkering down and wreaking havoc at the world’s most important chokepoint—has graduated from a tail risk to the base case.
Three dynamics explain why our base case is now the “Hydra Holdout.”
- Mining Changes the Timeline. Reports of IRGC “smart mine” deployments throughout the Strait of Hormuz have extended the conflict’s likely duration. Even with the U.S. Navy’s most advanced mine-countermeasures, declaring an “all-clear” in the Strait will probably require months, not weeks — which means the risk premium in oil markets will endure.
- Stocks Cannot Solve a Flow Problem. Markets are correctly discounting the limited protective power of International Energy (IEA) and Strategic Petroleum Reserve (SPR) releases. The stock of strategic reserves being released is unprecedented, but the physical bottleneck is insufficient flow. Drawing from the 2022 experience, the combined SPR/IEA release can likely pump no more than 3–3.5 million barrels per day (bpd) into an energy market facing a 20 million bpd disruption — not just to crude oil but also a long list of refined products.
- Mismatched Objectives. While Washington signals its desire for an exit ramp, Tehran’s new Supreme Leader appears intent on a collision course, aiming to extract a ruinous economic price to reconstitute strategic deterrence. When one side seeks a deal and the other seeks exhaustion, the conflict persists.
How Enduring is the Oil Shock?
The futures curve for Brent oil tells us that we’re in this shock for a couple of quarters. My judgment is that it’s fairly priced against a realistic mine-clearing timeline—but with no margin for error on Iran’s residual threat stack, i.e., mines, drones, missiles, and swarms of fast-attack craft.
March spot contracts ($100–$120/barrel) reflect the immediate bottleneck: a 2–4 week closure of the Strait of Hormuz, with near triple-digit prices reflecting the historic supply shortfall. Prices on second-quarter contracts ($90–$95/bbl) drop only marginally, which makes sense: neutralizing “smart mines” is a painstaking, object-by-object process measured in months, not weeks.
The meaningful price drop in June contracts ($80–$85/bbl) suggests the market is betting that by Q3, the U.S. will have certified enough transit lanes to permit escorted convoys, even if the broader Strait remains contested. Fair enough: the 1987–88 Tanker War precedent shows the U.S. can operationalize escorts under fire, and destroying 30+ Iranian minelayers has degraded Iran’s ability to meaningfully expand the minefield.
The Q4 portion of the curve ($75–$80/bbl) assumes full clearance and a return to the structural oversupply dynamics—U.S. shale growth, non-OPEC supply gains—that dominated the oil market in early January.
Also read: Iran Conflict Triggers Major Energy Shock
What the curve underprices is the reset risk: a single strike from Iran’s threat stack in a geographically confined chokepoint doesn’t just delay the recovery; it resets the timeline and spikes the risk premium back to today’s levels.
Why Policy Options, Like Suspending the Jones Act, or an Export Ban, Aren’t a Panacea
The U.S. Administration’s suspension of the Jones Act should help relieve structural friction in the U.S. energy supply chain. Under the Jones Act, any ship moving goods between two U.S. ports must be American-built and American-crewed. Because there are fewer than 100 of these “compliant” tankers, it’s often cheaper for New York or Boston to import fuel from overseas than to wait for a ship from Texas. By waiving the Act, the government is now allowing thousands of international tankers to carry fuel from the Gulf Coast to the Northeast. Even with more ships, however, the efficacy of the plan is limited by a mismatch: about 70% of U.S. refineries are built to process thick, “heavy” Middle Eastern crude, while the U.S. mainly produces “light” shale oil. Put plainly: the U.S. can now move fuel around more easily, but it still can’t refine enough of what it produces for self-sufficiency.
A second proposed lever—banning U.S. crude exports—carries similar limitations. Because most U.S. refining capacity is designed to process heavy crude, an export ban would create a domestic glut of light oil that U.S. refineries cannot absorb, potentially forcing plants to throttle down production and reducing the total supply of refined products. At the same time, pulling U.S. supply from the global market would spike the Brent benchmark along with domestic gas prices. Double whammy.
U.S. Macro Transmission: Inflation Accelerant
The oil shock will bite—though less like a growth killer and more as an inflation accelerant. A sustained move to $120 Brent would add roughly 0.7–1.0 percentage points to headline personal consumption expenditures (PCE) inflation and 15–20 bps to core PCE, due to upside pressure from energy-intensive services (e.g., transportation, industrial, and utilities).
The energy shock is arriving on top of existing supply-side constraints. In the labor market, net migration to the U.S. turned negative in 2025 for the first time in roughly half a century, per Brookings, pushing breakeven job growth into, or near, negative territory as the native-born working-age population shrinks and retirements accelerate.
In the trade sector, even after the Supreme Court’s IEEPA ruling, the statutory average U.S. tariff rate will likely settle near 15%—roughly 6x higher than in January 2025. The Administration has fast-tracked multiple Section 301 investigations covering almost the entirety of U.S. imports, with the explicit goal of restoring tariffs to pre-ruling levels before the 150-day Section 122 surcharge expires in mid-summer. As pre-April 2025 inventories are exhausted in the first half of 2026, and with the Customs and Border Protection becoming increasingly adept at policing transshipment, tariff passthrough to core goods CPI should accelerate throughout the year.
All told, U.S. PCE inflation looks likely to accelerate well above 3% — and possibly hit 4% — by end of summer, with core PCE hovering around 3% as well.
U.S. Growth Hit: Modest Topline Drag, Painful Sequence…
The growth hit from the energy shock to annual GDP in 2026 is on the order of 15–20 bps, but the modest topline drag masks a painful sequence. For consumption, the drag is immediate and regressive. At current Brent levels, the spending drag will amount to 0.5–0.7%, subtracting from a 2025 baseline of about 2.5%. The impact falls disproportionately on lower- and middle-income households, who generally lack the savings buffers to absorb a sustained energy cost spike without cutting discretionary purchases.
The positive growth offset from higher energy capex is, by contrast, lagged and uncertain. U.S. shale firms are reportedly prioritizing capital discipline over market share, treating the current price spike as a temporary geopolitical event rather than a structural shift. Even if this posture changes, history suggests a six- to nine-month lag between sustained price signals and meaningful increases in drilling activity—implying a U-shaped hit to GDP growth through 2026 on the order of 0.5% at the trough.
But Demand-Side Strength Remains Robust
Despite the energy shock triggering a meaningful near-term consumption dip, I am holding to an above-trend 2.7% U.S. real GDP forecast for 2026, anchored by three assumptions:
- AI capex is largely intact. Of the projected $700 billion in AI-related capex this year, roughly 75% is directly tied to AI infrastructure, and the bulk is already committed through purchase agreements for graphics processing units, long-term data center leases, and cloud compute contracts that carry significant cancellation costs. The logic is self-reinforcing: any hyperscaler that blinks on capex in response to a temporary macro shock risks losing competitive advantage in a winner-take-most infrastructure race, making this spending less sensitive to the energy price environment than virtually any other category of business investment.
- High-income spenders will likely smooth through the shock. High-income spending is wealthy-driven and largely immune to energy prices. The top decile accounts for nearly 50% of total U.S. consumption, and with the S&P 500 having more than doubled since the October 2022 trough—adding more than $25 trillion in market value, the vast bulk accruing to the top decile—that spending is functionally decoupled from $4.00/gallon pump prices.
- Bottom line: as a result of the two assumptions above, the key risk to AI capex and wealthy-driven consumption isn’t an oil price spike per se, but a sharp and sustained correction to tech valuations in the equity market.
Don’t Forget Fiscal: Path of Least Political Resistance = More Spending
A third source of demand resilience is a positive fiscal impulse that may grow even stronger in the aftermath of the energy shock. Last year’s stimulus, plus the reversal of the 2025 shutdown, already provides a front-loaded 1–2% GDP boost in 2026. The tax bill also created a withholding mismatch—its mid-year 2025 cuts were never reflected in withholding tables—producing record average refunds of nearly $4,000 this year, a 10% jump over last year. The fiscal injection is hitting households now, just as gas prices spike, and should peak in late March.
There is also a growing potential for Reconciliation 2.0. The House Budget Chair and the Republican Study Committee have already unveiled a fiscal framework packaging additional stimulus—centered around “affordability” as the key theme—that could include immediate relief from the energy price spike. If it follows through, it will pour more fuel on the demand fire just as the oil shock begins to wane into Q3.
U.S. Monetary Policy: Cuts Deferred, Not Abandoned
On monetary policy, I am revising my terminal rate forecast from 2.5% to 3.0%, with that level reached by end-2026 or early 2027. The oil shock has closed the door on the more aggressive easing path I previously envisioned—headline Personal Consumption Expenditures (PCE) running toward 4% this summer is simply not a rate cutting environment, especially with memories of 2022 still fresh for a new Fed Chair with something to prove on inflation credibility.
To be clear: I see this as a deferral, not an abandonment, of a dovish shift in Fed policy.
The cutting case reasserts itself in the second half as consumption growth softens, the oil price shock dissipates, and the AI-productivity signal becomes harder to dismiss: nonfarm business productivity has now run above 4% for two consecutive quarters, and Fed Chair nominee Kevin Warsh has staked his intellectual framework explicitly on the Greenspan 1990s analogy—that a forward-looking Fed should lean into a looming productivity boom rather than fight it.
How does it End?
The ongoing energy shock isn’t uniformly painful—and the map of winners and losers matters for how this ends. The near-term winners are the out-of-region exporters—Latin America, Norway, Canada, and the U.S. shale patch, which is collecting a windfall even while sitting on its hands. Russia is another beneficiary: every week the Strait stays closed, Moscow collects a larger energy windfall while Western attention and resources are consumed by a theatre far from Ukraine. The Gulf producers, meanwhile, face the irony of a price spike they can’t monetize: with storage filling and tankers unable to transit, Iraq and Kuwait have already been forced to cut production.
On the losing side, the shock is cleaving the emerging market universe: wealthier Asian importers can draw on reserves, but poorer fuel- and food-importing states in Africa and South Asia face immediate fiscal strain and potential social unrest. Europe, confronting a renewed energy crisis through the oil-gas price linkage, is too exposed to stay neutral, but has limited direct leverage over Tehran.
The most underappreciated source of pressure on Tehran may be from China. Its manufacturing economy runs on Gulf crude, which means Beijing has both exposure and leverage—as one of Iran’s primary patrons and its key economic lifeline. If the Strait remains closed into the scheduled Trump-Xi summit (now potentially delayed into April), the war in Iran will be the centerpiece of the agenda, and the key ask from the White House could involve help with brokering a face-saving exit.
