Growth grinds, inflation grows: Franklin Templeton Fixed Income macro view
Consumers are still spending, but real incomes are under pressure and discretionary demand is softening.
In its latest macro report, the Franklin Templeton Fixed Income team notes that global markets will face a more stagflationary backdrop as inflation pressures intensify, growth diverges and central banks stay on alert. Tech and artificial intelligence investment will continue to support the United States, as Europe wrestles with a fresh inflation shock, and Japan shows resilience.
But rising costs, supply strains and policy uncertainty cloud the outlook.
The US economy regained some momentum in the first quarter (Q1), led by tech-driven investment and stronger federal spending, but the backdrop is becoming more stagflationary. Higher oil prices, supply-chain disruption tied to the Strait of Hormuz closure, and artificial intelligence (AI)-related demand are adding to inflation pressures that already appear structurally closer to 3% than 2%.
Consumers are still spending, but real incomes are under pressure and discretionary demand is softening, even as the labor market remains broadly stable. Tech and AI investment continue to support growth, although supply bottlenecks pose rising risks.
“Our base case for monetary policy remains a protracted hold, but policy is finely balanced, with meaningful upside risks to interest rates. The key determinants will be whether inflation becomes broader, and the labor market re-tightens or weakens. The US dollar remains trapped in a range, reflecting a balance of opposing forces,” says Sonal Desai, chief investment officer Franklin Templeton Fixed Income.
Europe’s macro narrative since the start of the Middle East conflict resembles a stagflationary shock, but it is not a 2022 déjà vu. Unlike the Europe-specific gas crisis, this is a global shock, and Europe’s improved energy diversification means energy availability is no longer the prominent concern it once was. Still, the eurozone enters this shock from a weaker cyclical starting point, with softer demand, less labor-market tightness, and likely less room for second-round inflation effects. Recent data broadly fit the pattern of higher inflation and weaker growth, though hard data have held up better than surveys suggest so far. Headline inflation rising above 3% supports the view that the European Central Bank (ECB) can no longer look through the shock. After the June hike, another adjustment is coming, likely in September. All things considered, the euro has remained relatively resilient.
Japan’s near-term story remains one of resilience on the surface, with first quarter (Q1) 2026 growth holding up better than expected on the back of strong exports and consumption. Still, the picture is not without strain, as supply constraints, rising prices, declining sentiment, and yen weakness threaten to weigh on activity in the coming quarters, even if fiscal support should cushion the economy near term. Inflation has been more muted in the headline data, largely because policy support is capping energy and education costs, but underlying price pressures remain intact and are likely to build as higher energy costs feed through. Against that backdrop, markets expect the Bank of Japan (BoJ) to hike in June, while the yen may remain range-bound unless policy turns materially more hawkish.
