What if the fog gets thicker?
Investing means seeing beyond the ‘fog’ of the moment. But we are living in uncertain times. When uncertainty increases, the fog effectively becomes thicker, and the economic weather outlook may become less favourable.
From an investment perspective, we see a renewed escalation of the conflict between the US/Israel and Iran as the biggest risk. At present, the confrontation between the US and Iran is not so much a military conflict as it is an economic war. Both sides are using the Strait of Hormuz as leverage to strengthen their negotiating position. Disruptions to energy supply (oil and gas) are significant, bringing risks such as a further rise in inflation, pressure on company margins, and potential fuel shortages.
No Iran deal; inflation rises further
Central banks are, for now, trying to see through the fog created by the current energy shock, although they are not blind to the fact that inflation in the US and the EU has already risen sharply. We believe the European Central Bank (ECB) will raise interest rates in June and July. We expect the Federal Reserve (Fed) to keep interest rates unchanged for the time being. Toward the end of 2026, the Fed may begin a rate cutting cycle again.
But if the US and Iran fail to reach an agreement – and/or if violence escalates again – the disruption to energy supply could last even longer. In that scenario, inflation could rise higher than we currently expect.
We must also consider so-called second-round effects of higher oil prices. Rising oil prices can lead to higher wage demands, potentially triggering a wage-price spiral. These second-round effects can negatively impact the economy in several ways. First, they may reduce confidence among businesses and consumers, which is reflected in declining confidence indicators – something that is harmful to economic growth.
Second, inflation may rise even further due to these second-round effects. In that case, central banks would need to adjust their policy. The ECB would need to raise rates more aggressively than we currently assume. And, instead of cutting rates, the Fed would also need to implement rate hikes to contain inflation. This would be negative for growth and, consequently, for equity markets. Bond markets would also feel the impact in the form of rising yields. An additional challenge for investors is that ‘safe havens’ are becoming harder to find, making diversification more difficult.
Can AI meet expectations?
Expectations for AI are very high, both among companies and investors. Companies are making massive investments in AI, hoping to reap long-term benefits such as higher productivity and cost savings. However, the AI boom comes with risks.
“The pace of AI adoption could slow due to delays or postponements in investment or due to bottlenecks in data centres. And AI may put pressure on the business models of some companies if they fail to adapt in time.”
Joost Olde Riekerink – Equity Research & Advisory Expert
The pace at which AI is rolled out may fall short of expectations – for example, due to postponed investments or delays in building data centres. If AI progress slows, it will take longer to recoup the current large-scale investments. If investors begin to fear this scenario, they may view AI stock valuations as too high, putting pressure on share prices.
In addition, AI is a ‘disruptor’ – a force that changes the way we live and work. This creates opportunities for some companies, but it can threaten the business models of others. For example, AI could pose risks to certain players in the software and financial services industries.
How sustainable are government debts?
A third risk we want to highlight concerns government debt levels. In Europe, governments are taking on significant debt to finance large-scale investments. As a result, investors are demanding higher yields on long-term government bonds (a higher term premium). Rising yields are unfavourable for investors in government bonds, since bond prices fall when yields rise. For this reason, we remain cautious about this segment.
“European governments are borrowing heavily to fund their investments, driving up yields on long-term government bonds.”
Johanna Handte – Head Global Asset Allocation Team
In the US, government debt has now exceeded USD 39 trillion. In addition, the already large US budget deficit is expected to increase further, partly due to the war with Iran. As a result, the US government’s interest burden is enormous. A rate cutting cycle by the Fed, which we currently expect to start towards the end of this year, could offer some relief. However, in the more negative scenario outlined above, the Fed may need to raise rates instead – making the US debt problem even more pressing.
If the weather changes
In recent months, financial markets have been dominated by uncertainty. That uncertainty has not yet disappeared, even though economic ‘weather predictions’ are relatively favourable and companies are performing well. By maintaining a neutral allocation to both equities and bonds, we aim to balance opportunities and risks. Meanwhile, we closely monitor geopolitical, economic, and corporate developments. If the weather changes, we will adjust our investment strategy accordingly.
