Macro & Strategy - May 2026

Read the full article (PDF)open_in_new

Should I Stay or Should I Go

Central banks, supply shocks, and the art of choosing your trouble

“If I go, there will be trouble,
And if I stay, it will be double,
So come and let me know,
Should I stay or should I go?”
– The Clash

When inflation rises because supply gets hit, central banks end up facing the most uncomfortable choices.

Option one is to stay restrictive long enough to protect credibility, at the risk of breaking something in growth and credit. Option two is to pivot sooner to protect economic activity, at the risk of waking up inflation psychology. Either way spells trouble.

This time the catalyst is the energy episode tied to the U.S.-Israel-Iran conflict.

However, we’re not seeing a repeat of 2022. The Russia-Ukraine shock was largely a global commodity story (oil, gas, grains, metals, etc.) that swept a world already facing surefire inflationary pressures caused by the floods of money injected to alleviate the COVID hit.

The 2026 shock is more of a pure anxiety story of oil risk premiums and logistics. It could fade quickly if probabilities of escalation come down, or it could become persistent if physical flows, shipping routes, insurance costs, and precautionary inventory behaviour start to bite.

This month, we lay out the simple playbook for central banks facing inflationary supply shocks, discuss how it applies to the Federal Reserve (Fed), the Bank of Canada (BoC), and the European Central Bank (ECB), and estimate the odds of seeing global monetary policy turn restrictive.

The key takeaways from this piece are as follows:

1. Supply shocks force a trade-off that monetary policy cannot fully escape. Inflation goes up while growth momentum softens. Central banks can cool demand, but they cannot print barrels of oil or reopen shipping lanes. What they can do is prevent second-round effects and avoid a shift from a one-time price jump to a persistent inflation regime.

2. Credibility is the difference between a bump and a spiral. The 1970s remain the cautionary tale because expectations drifted and wage setting became backward-looking. Since the mid-1980s, stronger central banking frameworks and better-anchored expectations have generally made oil shocks less macro toxic. The catch is that anchoring isn’t a permanent state of nature and always must be defended.

3. The 2026 shock is more two-sided than the 2022 shock. Risk-premium episodes can reverse quickly, but physical shortages do not. While the current conflict has clearly lasted long enough to damage global supply, the news flow is bringing hopes of swift resolution. Markets can therefore swing from “back to normal” to “inflation is back” to “growth is cracking” with very little notice, which is why front-end rates can feel like a metronome.

4. The central bank playbook is simple, and it is not about headline CPI. Policymakers watch expectations first, then inflation breadth, then core momentum, then wages, and unit labour costs. Slack and growth matter mainly as the channel through which second-round inflation is either prevented or allowed to take root.

5. Respect market volatility, but do not confuse it with regime shift. In the early phase of a risk-premium shock, markets often overprice a higher-for-longer outcome. The next move depends on whether inflation breadth and wages follow. That is the fork in the road for duration, credit, equities, and currency positioning.

2026 ain’t 2022: Two energy shocks, two transmission mechanisms

2022: the perfect storm

In 2022, the global inflation story had multiple origins stacked on top of one another: too much money printing in reaction to COVID, unanchored inflation expectations, and rising wage pressures creating an intrinsic price spiral, followed by a supply shock on the whole commodity complex.

Global sanctions on Russian exports, including oil, gas, fertilizer, coal, industrial metals, and rare earths, combined with the loss of grains, oilseed, iron ore, and steel exports from Ukraine, created a perfect demand-pull and supply-push inflation shock that we hadn’t seen in close to 50 years.

Such an inflationary impulse had to be countered by aggressive rate hikes from global central banks, which had come into the shock with uber-accommodative monetary policies.

2026: An anxiety shock caused by crude oil’s risk premium and chokepoint

The current episode is different. Global central banks are entering it with a rather neutral stance, having generally achieved monetary policy normalization.

The shock is due to the intermittent closure of the Strait of Hormuz, the world’s key energy chokepoint, carrying 20 million barrels a day of oil and a fifth of global LNG trade. The supply shock is thus more centred on oil and gas, and more probability driven¹.

Prices move not only on barrels lost, but also on perceived odds of disruption, shipping rerouting, higher insurance premiums, and risk appetite. The outcome is largely a “riskpremium” shock, which tends to be nonlinear.

In a risk-premium shock, the first question is persistence. If tensions ease, oil can retrace quickly and the macro impulse will fade. If events worsen, or if logistics friction becomes the real story, then the shock behaves less like a financial premium and more like a supply constraint, with second-round dynamics becoming a real concern.

The uncomfortable reality for central banks is that they don’t get to choose the persistence of the shock. They only get to choose their response to it.

Why supply shocks are the hardest problem in macro

A demand-driven inflation cycle is a problem central bankers know how to fight. Tighten policy, cool the labour market, slow spending, and inflation eventually follows. A supply shock is different. Inflation rises as growth slows, which means the usual lever works, but with collateral damage.

A practical dilemma arises. If policymakers react aggressively to the headline move, they may crush demand just as households are already absorbing a tax-like hit through higher energy costs. If they look through the shock too comfortably, expectations can drift, pricing behaviour can change, and wages can start chasing prices.

At that point, the temporary becomes persistent.

Modern monetary frameworks were built to avoid repeating the worst lessons of the 1970s, when central bankers let inflation expectations become unanchored and kept nominal rates too low, leading to further accommodation through negative real rates.

The lesson, learned in any economics 101 classroom, is that central bank credibility and anchored inflation expectations are the key shock absorbers.

But credibility is not simply about communication, but rather a pattern of decisions. In an energy shock, the central bank must convince the public that it won’t allow a temporary price shock to morph into broad and sustained inflation.

So, the playbook is less about the first round and more about the second round. The first round is the supply shock. The second round is wage negotiations, the service inflation trend, and ultimately the breadth of price increases outside energy.

The central bank playbook² for inflationary supply shocks

Here is the simplest useful version of the playbook, in the order policymakers tend to care about it.

Expectations are the early warning system

Medium-term inflation expectations are the credibility dashboard. If they remain stable, central banks can afford patience. If they drift higher, patience ends quickly.

What matters most is not the one-year expectation that jumps with gasoline prices. It is the medium-term measure, the “What do you think inflation will be in three to five years?” question.

When that moves, central bankers need to pay attention and start defending their credibility, first through forward guidance and, if that isn’t enough, with an initial rate hike.

Breadth tells you whether energy is contaminating the basket

Breadth is the bridge between a relative price shock and a general inflation problem. A narrow shock is painful but manageable. A broad shock is a whole different animal.

Breadth can be tracked with diffusion indexes, trimmed mean measures, median CPI prints, and the share of components rising faster than a target-consistent pace. If the breadth line turns up, central banks start worrying about persistence even if headline inflation later stabilizes. Breadth determines the number and speed of initial rate hikes, as central bankers try to rein in both actual and expected inflation.

Core momentum is the persistence filter

Core inflation (inflation excluding food and energy) is not perfect, and certainly not very reactive, but it is the best quick test for whether the shock is leaking beyond energy. In practice, services inflation is the key, because it is labour-intensive and tends to be sticky.

If core momentum stays near target, central banks can tolerate the headline noise. If core momentum accelerates, the reaction function becomes more hawkish, even in the face of weaker growth.

Second-round effects show up in wages and unit labour costs

Wage growth is the mechanism whereby inflation becomes self-reinforcing. If a supply shock makes its way so far into realized and expected inflation that workers start negotiating for higher wages, then the inflation shock becomes an inflation spiral.

The vital issue is not a single wage print. It is whether wage setting becomes backward-looking. When negotiations start referencing last year’s headline CPI, credibility is tested.

Regional application: who can and cannot blink

Now let’s look at how the playbook applies across the main advanced-market central banks.

United States: The Fed as global anchor

Given the reserve currency status of the U.S. dollar, the Fed is clearly the main character in the global rates story. Even when the shock is global, the dollar curve is the reference point for term premia, risk appetite, and cross-border capital flows.

The Fed still hasn’t completely normalized its monetary policy

Given resilient U.S . growth and sticky inflation, the Fed is a rare major central bank entering this supply shock with a somewhat restrictive stance at 3.625 % (neutral is estimated at about 3%).

That changes the game: the question isn’t yet whether the Fed should raise rates in 2026, but rather whether it should refrain from cutting at all. Given the lofty expectations for two or three rate cuts at the start of the year, the markets’ repricing to no moves in 2026 acts de facto as a form of tightening in financial conditions.

We expect the Fed to look through a one-time energy jump if medium-term expectations remain anchored (survey and market data show this to be the case currently, although inflation swaps are sending a more cautious signal) and if core momentum stays well behaved. Despite the coming change at the helm, we don’t expect the Fed to gamble with its credibility if breadth and wages reaccelerate. In practice, the reaction function becomes asymmetric. The bar to cut rates is higher when inflation psychology is in question, and the bar to raise rates is lower when expectations threaten to drift.

Canada: The Bank of Canada in risk management mode

Canada’s inflation-targeting framework is clear. The target is 2%, with a 1-3% range. Such clarity is an asset in a supply shock, because it helps anchor expectations. The challenge is that the Canadian economy is particularly sensitive to interest rates through housing and mortgage refinancing dynamics.

We the North

In Canada, the growth side of the monetary policy trade-off is structurally more binding than in many peer economies because of the housing and mortgage transmission channel. A large share of Canadian households is exposed to interest rate resets over relatively short horizons, which means changes in policy rates feed into cashflows and consumption faster and more forcefully. In an inflationary supply shock, this dynamic amplifies the risk that restrictive policy will collide quickly with domestic demand, forcing the BoC to weigh inflation credibility against a sharper slowdown in housing activity and household spending.

The Canadian dollar adds another layer of complexity. Depending on global risk sentiment and changes in terms of trade, the currency can either cushion imported inflation or amplify it. In a risk-off environment, a weaker Canadian dollar can reinforce energy-driven inflation pressures by raising the local-currency cost of imports. With a more constructive global backdrop, commodity support and capital inflows can help stabilize or strengthen the currency, partially offsetting the inflation impulse. Thus, for the BoC, the exchange rate is a key transmission channel rather than a sideshow.

Finally, Canada’s energy exposure creates an uneven macro landscape.

Higher energy prices can support incomes, investments, and fiscal revenues in energy-producing regions, while acting as a tax on consumers and businesses elsewhere in the country. The result is a patchwork economy: Some regions benefit from the shock and others absorb the pain. From a policy perspective, this regional asymmetry complicates the signal coming from national aggregates and reinforces the need for the BoC to focus on inflation persistence and second-round effects rather than reacting mechanically to headline energy moves.

What matters most for the Bank of Canada

The BoC will focus on the same hierarchy: expectations, breadth, core, and wages. But it will be especially alert to the risk that a supply shock slows growth quickly while the inflation impulse is still in the data. That is the tightrope. For markets, this often translates into more rate volatility at the front end . If growth cracks, cuts get priced in quickly. If inflation breadth stays firm, cuts get delayed just as quickly.

ECB and the memory of 2022

Europe’s households and policymakers have fresh scar tissue from the last energy shock. The 2022 experience was a reminder that energy can seep into core inflation with a lag and stick around longer than the headline suggests. Energy shocks in Europe have a habit of leaking into the core inflation basket more slowly but more persistently than investors expect, given Europe’s status as a net energy importer. Through electricity pricing, industrial inputs, and services costs, energy shocks can embed themselves in core inflation with long lags, raising the risk that the inflation impulse will outlive the initial price move. Thus, inflation breadth is a critical signal for the ECB. Breadth tells policymakers whether the shock remains a relative price adjustment or whether it is becoming generalized across goods and services. Once breadth deteriorates, the odds rise that pricing behaviour and wage setting are adjusting to a higher inflation environment, narrowing the ECB’s room to look through headline volatility.

The growth-inflation trade-off is further complicated by fiscal and political constraints across member states. Energy shocks do not hit the euro area symmetrically, and the scope for fiscal offset varies widely across countries. That heterogeneity makes it harder to rely on fiscal policy to smooth the cycle and increases the burden on monetary policy to protect price stability at the aggregate level.

The ECB’s framework puts price stability first, which typically lowers its tolerance for any drift in inflation expectations. In practice, the ECB can look through a temporary energy-driven jump in headline inflation, but only if there is clear evidence that core momentum is cooling and that wage agreements remain consistent with the inflation target over time. Without that confirmation, the bias naturally shifts toward defending credibility, even if growth momentum softens.

Conclusion: Choosing your trouble

Central banks are once again stuck with the question that never really goes away: Do they tighten policy to ensure the shock does not become a wage and expectations story, or do they stay on the sidelines to limit damage to growth, trusting that credibility will hold? The playbook is clear. Watch expectations, then breadth, then core momentum, then wages. That is where the temporary becomes persistent. Everything else is noise, even when it is loud noise.

Positioning

Our positioning has shifted modestly in April, with a continued overweight in equities, but with a rotation back toward the U.S. and broader North American markets. The global growth impulse remains intact but is becoming more uneven, with North America benefitting from relative energy insulation, stronger balance sheets, and a more resilient earnings backdrop. By contrast, parts of Europe and Asia remain more exposed to external energy-price shocks, tighter financial conditions, and weaker domestic demand.

After a period of meaningful outperformance by non-U.S. equities, relative momentum and risk-adjusted return prospects now favour reallocating capital to markets with greater earnings visibility, deeper liquidity, and more policy flexibility. This context doesn’t negate the longer-term case for diversification, but it argues for a tactical recentring of equity risk in North America at this stage of the cycle.

In currencies, we continue to underweight the U.S. dollar on a broad basis. The dollar’s cyclical support has been eroded by a combination of easing inflation surprises, a narrowing growth differential, and a gradual normalization of global risk sentiment. At the same time, external balances are adjusting in a way that favours selective non-U.S. currencies, particularly those tied to commodity production and terms of trade improvements.

Importantly, the dollar is also delivering diminishing marginal protection against geopolitical headlines, as markets appear less sensitive to shock-driven risk aversion than in prior episodes. In this environment, the structural headwinds facing the dollar are reasserting themselves, even if the path lower remains uneven and punctuated by short-term rallies.

Finally, we remain underweight global government bonds. While nominal yields are more attractive than in recent years, the fundamental backdrop continues to argue against a sustained rally in duration. Fiscal policy remains loose, term premia are elevated, and external shocks — particularly those tied to energy and geopolitics — risk keeping inflation volatility higher than what is currently discounted . Moreover, cross-market correlations have become less favourable for bonds as a hedge, especially in regions that are structurally more exposed to imported inflation and higher financing costs. Against this backdrop, we continue to see limited upside in long-duration government bonds and prefer to express macro views through equities and currencies, where dispersion and asymmetry remain more compelling.