S&P 500 Posts Worst Quarter Since Q3 2022 Amid Geopolitical Tensions and Inflation Pressure

Amid heightened Iran tensions, growing stress in private credit, and a rotation out of AI-related names, large-cap equities struggled in Q1 2026. The S&P 500 Index declined 4.3%, marking its worst quarter since Q3 2022, while the tech-heavy Nasdaq 100 Index fell 5.8%. By contrast, the S&P 500 Equal Weight Index rose 0.7%. Rotation pockets held up better: US small-caps gained 3.5%, international developed equities rose 2.8%, and US mid-caps increased 2.6%.

Rates decision and inflation keep uncertainty elevated

The Federal Reserve held the federal funds rate steady at the March FOMC meeting in an 11–1 vote, maintaining the target range at 3.50–3.75%. This was the second consecutive rate hold in 2026. Governor Christopher Waller cast the lone dissent, favoring a 25 basis point cut.

The decision came against a mixed but cautious economic backdrop. The February employment report showed Nonfarm Payrolls down 92,000 versus expectations for an increase, while the unemployment rate rose to 4.4% from the unchanged 4.3% estimate. Inflation, however, was stronger than expected: February PPI readings were hotter than forecast across the board, leaving annualized core PPI at 3.9%.

Fed Chair Jerome Powell said the policy stance remains “appropriately restrictive” and that officials will continue to monitor incoming data and the balance of risks, including geopolitical developments. Looking ahead to April, the CME FedWatch Tool priced another hold with a 99% probability. The remaining probability has shifted toward a hike, with a cut now off the table.

Geopolitical tensions drive volatility in energy and commodities

Over March, geopolitical risk became a dominant market theme as tensions among the United States, Israel, and Iran escalated. The conflict intensified from shipping disruptions tied to the effective closing of the Strait of Hormuz to direct strikes on critical infrastructure, contributing to sharp volatility across commodity markets.

Brent and WTI crude oil prices surged, reaching highs above $119 during the month, largely attributed to the effective closure of the strait. Approximately 80% of the oil and LNG transiting through the strait is destined for Asia, and key regional exporters—including Saudi Arabia, Kuwait, Qatar, Iraq, and Iran—play a role in global energy supply. Refined products such as jet fuel also saw sharp price increases.

Beyond crude oil and LNG, nitrogen-based fertilizers (including urea and ammonia), other agricultural inputs, and industrial metals such as aluminum and nickel experienced heightened volatility as supply bottlenecks and shipping delays disrupted global markets and pushed up costs across food, energy, and industrial supply chains.

Commodities surge while bonds are mixed

Commodities delivered strong positive returns in Q1 2026. Crude oil rose 84.0%, broad-based commodities increased 24.4%, gold gained 8.6%, and silver rose 5.8%. Bonds were mixed: Treasury Inflation Protected Notes and the US Aggregate Bond Index were up marginally (+0.3% and +0.1%, respectively), while high yield credits and municipal bonds fell (-0.4% each).

Stagflation fears resurface as yields rise and growth softens

Despite a market rally on the final day of March amid signs of potential off-ramps to end the war, some economic damage may already be underway. Concerns about stagflation—slowing growth alongside persistent inflation—have resurfaced as higher energy prices and elevated bond yields create a challenging environment for central banks.

Even after pulling back from recent highs, 2-year yields globally moved higher as investors reduced expectations for near-term rate cuts. Markets are now pricing at least two rate hikes from the Bank of England this year, shifting from earlier expectations of one to two cuts before the war began. A similar tightening bias is expected from the European Central Bank, as Eurozone headline annualized inflation rose from 1.9% in February to a flash estimate of 2.5% in March, one of the largest monthly increases since 2022.

S&P Global flash PMI data also pointed to weakening private sector growth across the Eurozone in March, with cost pressures rising alongside moderating output. In the US, March flash PMI data showed slowing business activity alongside elevated input price pressures, raising the question of whether stagflation pressures remain concentrated internationally or extend to the US.

Valuation reset may create an opportunity for US equities

Over the past month, the S&P 500 experienced a notable valuation derating, with its NTM P/E multiple compressing by as much as 17%. At the same time, consensus NTM EPS growth expectations moved higher, reflecting a disconnect between valuations and earnings amid AI-related and geopolitical pressures.

Morgan Stanley Research said forward returns have historically been above average when NTM P/E drawdowns exceed 10%, earnings growth is inflecting higher, and earnings revisions breadth remains positive. The firm cited that in the following month the market delivered positive returns 69% of the time, with a median gain of 3% versus an all-days average of 1% since 1996. Over three months, the positive hit rate rose to 75%, with a median return of 7% versus a long-term average of 2%. For six- and twelve-month horizons, positive hit rates were 81% and 69%, respectively.

The research also noted that, unlike past oil shocks, Brent crude has not surged as sharply, and that earnings growth is currently accelerating and positive, whereas it was decelerating and negative in prior recessionary periods. Despite the ongoing conflict, this combination of valuation and earnings dynamics was described as pointing to a potentially attractive entry point for equities.