Investment booms outweigh challenges

Inflation is proving to be quite sticky as oil prices rose back to more than USD 100 per barrel. This surge in oil prices is driven by the lingering war with Iran, the closure of the Strait of Hormuz, and more recent Middle East developments, including the attack on the east-west oil pipeline in Saudi Arabia and the advances of the Houthi rebels near the Red Sea.

Based on these events, we now expect the price of oil, inflation and interest rates to be higher for longer. This will be a drag on economic growth, especially next year. However, investment booms in AI, green energy and defence are large enough that we still expect economic growth in all major regions next year.

In line with these developments, the Federal Reserve (Fed) has unanimously decided to raise its policy interest rate by 25 basis points. The decision affirms that Fed Chair Kevin Warsh will not bend the knee to President Donald Trump and will keep the Fed’s independence intact, which is reassuring for investors. We still expect one more rate hike from the Fed this year. For the ECB, which also hiked in September, we expect two more hikes this year.

Long-dated government bond yields have risen significantly over the past few months, mostly driven by higher inflation expectations caused by rising oil and gas prices. In the US, Japan, Germany and France, government bond yields have reached multi-year highs. But bond yields have also risen on investor worries about economies with weak fiscal positions such as France, Japan and the US. Widening spreads between French and German government bonds show that investors punish countries with higher debt levels and deficits.

These developments support the cautious view that we have had on government bonds for quite some time within high-quality (HQ) bonds. Simultaneously, we remain constructive on high-quality corporate bonds as they provide more attractive risk-return characteristics.

Compared to current bond yield levels, we expect some further upward pressure in the near term, as central banks are expected to raise interest rates further before the end of 2026. However, we expect yields to decline during the course of 2027 because we expect the eventual peak in rates to be lower than markets are currently pricing, while at the end of the horizon we expect markets to start pricing in rate cuts.

Elevated oil prices, sticky inflation and central bank rate hikes are recent challenges that demand attention from equity investors, but equity markets have proven to be resilient. The enormous investments in AI continue to be a big driver for economic growth and corporate profits. Especially in the US and emerging markets. The continued growth outlook across all major regions, albeit slightly lower than our earlier projections, supports a constructive view on equities. Moreover, corporate earnings growth expectations for the coming year remain solid with double-digit growth projections. Here, we are starting to see that earnings growth is no longer contained to the primary beneficiaries of the investment booms, but is becoming more widespread across the market. Finally, although valuations are still stretched from an historical standpoint, strong earnings and sideways moving markets have made them a bit more attractive. With these points in mind, we keep an overweight position in equities with regional preferences for emerging markets and the US.

Recent developments around rising oil prices, sticky inflation and rising interest rates have caused some worry for investors. Although we do see these factors as a drag on economic growth, a combination of investment booms outweighs them. Therefore, we still expect economic growth in all major regions. For bonds, we prefer HQ corporate bonds compared to HQ government bonds given the more attractive risk return characteristics. In our equity portfolio, we prefer the US and emerging markets based on their attractive earnings growth expectations. Finally, gold provides portfolio diversification while benefiting from long-term tailwinds.

Johanna Handte
Acting Chair Global Investment Committee