Adrian Schmidt

Senior FX Strategist

Dave Sloan

Senior Economist

North America

PakLai Ng

Technical Analyst

Cephas Kin Long Yung

FX Analyst

Mike Macdonald

Senior Technical Strategist

Volkan Sezgin

Senior EMEA Economist

Sanya Suri

Senior Asia Economist

Marlon Chacon

Senior Quantatitive Economist

Mike Gallagher

Director of Research

Macroeconomics and Strategy

UNITED STATES

UNITED KINGDOM

CHINA

INDIA

INDONESIA

SOUTH AFRICA

GERMANY

JAPAN

TURKEY

SWEDEN

SWITZERLAND

Our March Outlook is now published and please see all our economic and policy chapters below.  

March Outlook: Iran War and AI Challenges

BRAZIL

MEXICO

ARGENTINA

AUSTRALIA

NEW ZEALAND

CANADA

MALAYSIA

&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Outside of Iran, geopolitics will look at Taiwan. Though President Xi will likely ask Trump not to get involved in Taiwan reunification, Trump administration officials will likely ensure that Trump does not drop the strategic ambiguity policy when they eventually meet. &nbsp;Odds of a China attack on Taiwan remain at 5-10% for 2026-27, given the very high risks involved.&nbsp; Meanwhile, we believe that a Russia-friendly peace deal in Ukraine could eventually arrive by H1 2027 due to exhaustion, with only a 30% chance of occurring this year. &nbsp;Elsewhere, the Donroe doctrine should also be watched closely, as Trump adventurism is likely to still leave him inclined to pressure Cuba and Greenland later this year &ndash; though more military action is unlikely following the Iran war problems. We would still suspect that U.S./Europe could find a negotiated solution for Greenland (<a target="_blank" href="https://continuumeconomics.com/a/942327fc/europe-nuclear-weapons-nato-and-greenland">here</a>), while Trump will also be preoccupied with the mid-term elections in November.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; For financial markets, a 4-8 week Iran war will likely see inflation fears reduced and allowing 2yr yields to undiscount tightening. In H2 start to speculate on rate cuts again in the U.S. and to a degree in EZ/UK. U.S. 10yr yields can see a slight reduction but are unlikely to fall below 4%, while German fiscal spending means that 10yr Bund yields will remain sticky around 3%.&nbsp; 10yr JGB yields will keep rising however, as the BOJ QT reaches close to 6% of GDP but this will likely force a BOJ QT U turn by mid-year.&nbsp; U.S. equities may have less fears over Iran by the spring, but are overvalued still and vulnerable to consumption slowing down to the weaker pace of income growth.&nbsp; However, by the end of 2026 we forecast a rebound in the S&amp;P500 to 7200. In terms of 2027, U.S. job losses from AI could be more noticeable and cause a fear factor among consumers that dents consumption and growth. The economic cycle will also be more mature. This risks a new deeper correction in the overvalued U.S. equity market.&nbsp; We see the S&amp;P500 to 7000 by end 2027. Other DM equity markets and China will find it difficult to outperform the U.S. in 2026, as markets are no longer cheap.&nbsp; India equities could start to see some recovery in H2 2026, with fwd P/E ratio less overvalued.&nbsp; In FX, the USD can see a slow decline resuming versus most DM currencies, with the AUD and NOK remains our favorite on valuation; structural fundamentals and policy rate grounds. JPY is also extremely undervalued and could snap higher.&nbsp;&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Risks to our views: A 2-to-6 months Iran war can spike WTI to USD 120-180 (depends on duration of the war and further damage) and remain elevated for the remainder of 2026.&nbsp; This would prompt a stagflation hit to the global economy; cancel interest rate cuts and in some cases prompt modest rate hikes to lean against 2nd round effects.&nbsp; It would likely stop the Fed from easing further initially. However, if the shock caused a U.S. recession, then the Fed would cut policy rates to 2% or lower, which would see 2yr yields drop but sharp yield curve steepening and a U.S. equity bear market. Fiscal policy would provide less of a buffer due to limited fiscal space in most major countries, except balance sheet strong DM countries.&nbsp;Figure 1: Economic Scenarios<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c55cb6e5685.JPG" style="width:100%;"></figure>&nbsp;Source: Continuum EconomicsMarket ImplicationsFigure 2: Asset Allocation for the Next 9 Months<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c16c717cd74.JPG" style="width:100%;"></figure>&nbsp;&nbsp;Source: Continuum Economics Note: Asset views in absolute total returns from levels on March 23 2026 (e.g., 0 = -5 to +5%, +1 = 5-10%, +2 = 10% plus).&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Government Bonds. A 4-to-8 week war will likely reduce inflation fears and allowing 2yr yields to undiscount tightening and in H2 start to speculate on rate cuts again in the U.S. and to a degree in EZ/UK. U.S. 10yr yields may see a slight reduction but are unlikely to fall below 4%, while German fiscal spending means that 10yr Bund yields remain sticky around 3%.&nbsp;&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Equities. &nbsp;U.S. equities may have less fears over Iran by the spring, but are overvalued still and vulnerable to consumption slowing down to the weaker pace of income growth.&nbsp;6000 should be the bottom. However, by the end of 2026, we forecast a rebound in the S&amp;P500 to 7200. In terms of 2027, U.S. job losses from AI could be more noticeable and cause a fear factor among consumers that dents consumption and growth. We see the S&amp;P500 to 7000 by the end of 2027. Other DM equity markets and China will find it difficult to outperform the U.S. in 2026, as markets are no longer cheap.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; FX. &nbsp;The USD can see a slow decline resuming versus most DM currencies, with the AUD and NOK remaining our favourite of valuation; structural fundamentals and policy rate grounds. JPY is also extremely undervalued and could snap higher.&nbsp; In EM, the Brazilian Real remains attractive on a total return basis in 2026, helped by wide nominal and real interest rate differentials. &nbsp;&nbsp;&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Commodities. Our baseline (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>) is for a 4-8 week war, with WTI down to USD80-85 by June; USD65-70 end 2026 and USD60 by Q3 2027.&nbsp; A 2-to-6-month war would require oil prices to trigger demand destruction as strategic stockpile release would be insufficient. WTI to USD 120-180 (depending on duration and damage) and remain elevated for the remainder of 2026.&nbsp;&nbsp; &nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;Figure 3: Key Events<figure class="table"><table><tbody><tr><td style="background-color:#DDE5EA; border:1.0pt solid white">May 2026</td><td style="background-color:#DDE5EA">Powell Replaced as Fed Chair</td><td style="background-color:#F2F2F2">Powell is set to be replaced as Fed Chair in May, though his replacement by former Fed Governor Kevin Warsh could be delayed, with a key Republican Senator (North Carolina&rsquo;s Thom Tillis, who is not seeking re-election) threatening to delay confirmation as long as a legal investigation into Powell continues. Warsh will advocate a more dovish stance, on the grounds that rising productivity will reduce inflation, but may struggle to receive majority support for this in FOMC voting. He also wants to reduce the size of the balance sheet, but others on the FOMC oppose this idea. &nbsp;</td></tr><tr><td style="background-color:#DDE5EA">July 2026</td><td style="background-color:#DDE5EA">USMCA Renegotiations</td><td style="background-color:#F2F2F2">President Trump has made clear that he wants to renegotiate USMCA and new threats will be used as a negotiating tool by summer.&nbsp; However, a deal will likely be reached by end 2026/early 2027, with USTR Greer indicating that an addendum could be added to the existing agreement with bilateral sub deals for Canada and Mexico.&nbsp; Odds of the U.S. not renewing USMCA are low, but if it did occur then the agreement would technically run until 2036. &nbsp;</td></tr><tr><td style="background-color:#DDE5EA">September 13, 2026</td><td style="background-color:#DDE5EA">Sweden General Election</td><td style="background-color:#F2F2F2">The current right-wing coalition still has a very slim effective majority in parliament even with the far-right Sweden Democrats offering support.&nbsp; This is all the result of the 2022 election, which brought a fragmented result but locking out the Social Democrats even though they are the largest party.&nbsp; This fragmentation was a result of a more polarized parliament, and polls suggest more of the same, but with a general drip more to the left.&nbsp; But even if left-leaning parties return to power, it is unlikely to change much given the current focus on defence but where an election issue may be a speedier defence build-up.</td></tr><tr><td style="background-color:#DDE5EA">By September 20, 2026</td><td style="background-color:#DDE5EA">Russia Parliamentary Elections</td><td style="background-color:#F2F2F2">Russia is set to hold its next parliamentary elections by September 20, 2026 to determine the State Duma, the lower house of the Federal Assembly. All 450 seats are up for grabs, with 226 needed for a majority. As of current polling trends, United Russia (YeR) leads with around 35%-40% support; Communist Party (KPRF) trails with 10%; and Liberal Democratic Party (LDPR) also holds 8%-10%. We expect United Russia, led by Dmitry Medvedev, will likely remain dominant after its 2021 victory.</td></tr><tr><td style="background-color:#DDE5EA">October 4 and 25, 2026</td><td style="background-color:#DDE5EA">Brazil General Election</td><td style="background-color:#F2F2F2">In 2026, Brazil will hold general elections to elect the next President, renew all the Chamber of Deputies seats, and two-thirds of the Senate, while also electing the governors of all Brazilian states. Lula will seek re-election, while opinion polls suggest Lula could face Flavio Bolsonaro who has overtaken Tarc&iacute;sio de Freitas (an ex-Bolsonaro minister), with the race being too close to call at this stage.&nbsp; Pre-election fiscal easing will likely be seen.</td></tr><tr><td style="background-color:#DDE5EA">November 3, 2026</td><td style="background-color:#DDE5EA">U.S. Mid Term Elections</td><td style="background-color:#F2F2F2">All seats in the House and a third of the seats in the Senate will be up for election.&nbsp; With the current Republican majority in the House being marginal even a modest level of disappointment in the Trump administration, which seems likely, would be enough to see the Democrats gain control of the House. It will harder for the Democrats to make the necessary gain of 4 seats in the Senate, though they look likely to make gains in Maine and North Carolina, and Trump&rsquo;s increasing unpopularity now makes the Senate a close call. States to watch are Alaska, Ohio and Texas.</td></tr><tr><td style="background-color:#DDE5EA">May 2027</td><td style="background-color:#DDE5EA">French Presidential Election</td><td style="background-color:#F2F2F2">Opinion polls and this month&rsquo;s local elections suggest that if/when a fresh legislative election occurs, this will not change parliament materially meaning insufficient fiscal consolidation.&nbsp; President Macron has ruled out fresh parliamentary elections and they are not due until 2029. The 2027 presidential election will likely see all other main parties supporting a candidate to prevent the National Rally getting the presidency.&nbsp; However, it is not yet clear who this will be, but it is unlikely to resolve the slow progress in reducing the budget deficit.&nbsp; We feel France will face fiscal pressure and could face a fiscal crisis.&nbsp;&nbsp;</td></tr><tr><td style="background-color:#DDE5EA">Aug 2027</td><td style="background-color:#DDE5EA">Spain General Election</td><td style="background-color:#F2F2F2">The election is scheduled to occur by Aug 22, although one could occur much earlier if the current Socialist administration&rsquo;s run of scandals deepens enough and/or the diplomatic friction with Trump persuades PM Sanchez to get electoral support.&nbsp; He has tried to rule out such a snap vote out and insisted he will stand for office again.&nbsp; Either way it does look as if there would be a change in who runs the country, given the right of centre People&rsquo;s Party lead in the polls, the question being how much of a swing to the right would occur depending upon who the PP go into coalition with.</td></tr><tr><td style="background-color:#DDE5EA">Sep-Oct 2027</td><td style="background-color:#DDE5EA">Italian General Election</td><td style="background-color:#F2F2F2">The election has to occur by late December, but is more likely to occur earlier, probably in September.&nbsp; As for the possible result, important wins for Italy's opposition in southern regional elections recently show cracks in the ruling conservative bloc's dominance, raising doubts over PM Meloni's ability to secure a second term.&nbsp; However, at this juncture, Meloni&rsquo;s coalition (her Brothers of Italy party, Forza Italia and the far-right League) are ahead in national polls while the opposition needs to unify more after years of mutual hostility.</td></tr><tr><td style="background-color:#DDE5EA">Oct/Nov 2027</td><td style="background-color:#DDE5EA">Turkiye Presidential Election&nbsp;</td><td style="background-color:#F2F2F2">Parliamentary elections in&nbsp;Turkiye&nbsp;are scheduled to occur no later than May&nbsp;14, 2028, alongside&nbsp;presidential elections. We expect the elections to be held in October/November 2027, earlier than the scheduled time. This timing is critical, as an early election called by Parliament is the only constitutional path for President Erdo&#287;an to seek another term. The presidential race will be between AKP&rsquo;s candidate and an opposition candidate supported by CHP. Taking into account that CHP&rsquo;s official presidential candidate Ekrem Imamoglu is still in jail, he will likely be replaced by someone else (such as Ankara Mayor Mansur Yava&#351; or CHP Chairman Ozgur Ozel) if Imamoglu won&rsquo;t be released before 2027. We expect a close race between AKP/MHP block (People's Alliance) and the CHP for the parliamentary elections.</td></tr><tr><td style="background-color:#DDE5EA">Oct-Nov 2027</td><td style="background-color:#DDE5EA">Argentina General Election</td><td style="background-color:#F2F2F2">President Javier Milei&rsquo;s administration has been boosted by October 2025 election results that saw his party (La Libertad Avanza LLA) doing better than expected in mid-term elections.&nbsp; USD2bln of U.S. Treasury FX purchases and a USD20bln credit line from Milei&rsquo;s friend, U.S. President Trump, helped to reduce financial market volatility and boost Milei support. Trump has rewarded Milei with a trade deal in 2026. The continued slowing in inflation and fear of returning to economic instability should also support Milei and LLA in the 2027 general election. &nbsp;However, 2025 had shown how fluid voter behaviour is and the situation needs to be monitored near the 2027 elections.&nbsp;</td></tr></tbody></table></figure>

·       The Iran war macro impact depends on length of the conflict and impact on energy flows. Our baseline is for a 4-8 week Iran war, with WTI dow

Outlook Overview: Iran War and AI Challenges

Macro Strategy

DM Central Banks

Outlook

Editor's Choice

Eurozone

Outlook Overview

DM Country Research

EM Country Research

EM Central Banks

U.S. Consumers Vulnerable, but Investment Strong<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c18260ce89c.jpg" style="width:100%;"></figure>U.S. GDP surprised to the upside in the second half of 2025, largely in Q3, meaning that 2025 GDP increased by 2.1% rather than our December forecast of 1.8%, which was made with Q3 data still unavailable due to the to the impact of the government shutdown. While Q4 at 0.7% annualized was significantly slower than a 4.4% increase in Q3, slippage from the Federal Government, hit by the temporary effects of the shutdown, took 1.2% off the increase, suggesting that the economy maintained respectable underlying momentum entering 2026.There are a number of special factors that complicate forecasts for early 2026. The ending of the government shutdown will be supportive for Q1 GDP, though this will be in part offset by bad weather in late January and much of February. Any negative from bad weather in Q1 is likely to be made up in Q2. Both Q1 and Q2 will see support from fiscal policy, with tax measures in the One Big Beautiful Bill passed in July 2025 likely to add around 0.3% to GDP in 2026, which will be felt most in the first half of the year. However, the lift to consumers from lower taxes could be more than fully offset, at least in the short term, by higher energy prices due to the conflict in the Middle East.In December we saw US consumers as vulnerable to a slowing, but the outlook outside of consumer spending as more positive. That remains the case. Consumer spending increased by 3.5% annualized in Q3 of 2025 and 2.0% in Q4, but real disposable income rose by only 1.0% in Q3 and 0.2% in Q4, reflecting weak employment growth, and resilient inflation restraining real wage growth. Consumer spending looks set to lose momentum in 2026. The outlook for investment however, fueled in particular by AI,&nbsp; is looking increasingly positive. Trend in durable goods orders has picked up and the ISM manufacturing index has moved clearly above neutral in early 2026. The Fed&rsquo;s Senior Loan Officer Opinion Survey shows demand for commercial and industrial loans picked up in the second half of 2025. Inventories, having corrected a pre-tariff surge in Q1 of 2025, are now quite lean. The impact of the other components of GDP is likely to be modest. Government will remain subdued, but the steep DOGE-fueled cuts seen in early 2025 will not be repeated and increased defense spending will be a positive for GDP. Housing, which declined in 2025, has shown signs of stabilization but has limited upside.Underlying inflation to slow with tariffs having peakedNet exports saw massive swings in the quarterly GDP data of 2025 but the trade deficit for 2025 as a whole was almost unchanged from that of 2024. Going forward we expect net exports to return to a long-term trend of being a modest negative in GDP. Strong US investment will fuel imports. The tariff situation remains highly uncertain with Trump determined to fight the Supreme Court ruling against his reciprocal tariffs in any way he can, and he has several options. However, his right to impose across the board 15% tariffs lasts for only 150 days before he will require the approval of Congress, which is unlikely to be forthcoming. This leaves the more complicated section 301 for negotiating leverage and to get existing trade framework deals codified.&nbsp; Tariffs will remain significant, but will be off the 2025 highs, and that will help underlying inflation excluding energy to fall in the second half of 2026, by when we assume energy prices will also be coming off their highs induced by the conflict in the Middle East.We expect GDP to increase by an in line with potential 1.9% Q4/Q4 in both 2026 and 2027, a marginal slowing from 2.0% in 2025 Q4/Q4. However, given the strong second half of 2025, we now expect 2026 to average 2.2% y/y, up from 2.1% in 2025, before a slowing to 1.8% in 2027. We expect annualized gains slightly above 2.0% in the first half of 2026, with the second half falling below the 1.9% pace where we expect growth to stabilize through 2027. There are downside risks should conflict in the Middle East prove protracted.We now expect inflation to average slightly more in 2026 than 2025 as a whole, with CPI at 3.2% and core PCE prices at 2.9% compared to 2.7% and 2.8% respectively in 2025, before 2027 sees both CPI and core PCE prices slowing to 2.2%. Annualized core PCE prices are likely to remain significantly above target in the first half of 2026 before slowing to only slightly above the 2.0% target in H2 2026, and that is where we expect the pace to remain through 2027. A less globalized world, the likelihood of Fed policy slightly more dovish than appropriate, and a continued expansionary fiscal policy suggest that the Fed will fail to quite reach its target, even as the impact of tariffs and the current energy shock fade.<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c182852abbf.JPG" style="width:100%;"></figure>Fed Policy and Political RiskThe term of current Fed Chair Jerome Powell ends in May but with a key Republican Senator threatening to delay approval of his nominated successor Kevin Warsh while legal action against Powell persists it is uncertain when Warsh will assume the position, though his eventual approval is not in serious doubt. Warsh will be eager to move the Fed in a dovish direction, on a view that AI-fueled investment will boost productivity and lower inflation, but many at the Fed have doubts over this view (<a target="_blank" href="https://continuumeconomics.com/a/4eeaa851/ai-fed-and-inflation-and-disinflation-risks">here</a>). Some feel that strong investment will increase the neutral rate, and there is tentative evidence in GDP price indices and the PPI that inflation for investment goods is accelerating ahead of consumer prices. The economy is entering 2026 with economic growth maintaining some momentum and inflation remaining above target. If activity data shows weakness, it will be difficult to distinguish the impact of short term and underlying factors, while gains in energy prices add to the risk of current inflation becoming embedded into expectations. We continue to expect the Fed to ease by 50bps in 2026 with core inflation likely to fall and labor market data to remain subdued, but we now expect the moves to come in Q3 and Q4, rather than Q2 and Q3. Our call is now for moves in September &nbsp;and December, though timing will be dependent on incoming data which will be sensitive to geopolitical events. A protracted war in the Middle East would be likely to delay easing further.We expect policy to be held steady through 2027 with growth seen near potential and inflation seen near target, though marginally above, through that year. We believe the neutral rate is marginally above 3.0% but there is a wide range of views on this at the Fed. Warsh is also keen to reduce the size of the balance sheet, but other on the FOMC have different views. Previous attempts to reduce the balance sheet below current levels have created strains in the money market and that is something to watch for.The key political event, assuming an end to the Middle East war, will be the November midterm elections. It looks highly likely that the Democrats will achieve the small net gain required to take control of the House. The Senate will be harder for them to win, needing a net gain of four seats and only two of the contested seats (Maine and North Carolina) being in states currently recognized as swing. However, should Trump become increasingly unpopular, a Democratic Senate, which would dramatically curb Trump&rsquo;s power, is a real possibility. There are close races in Alaska and Ohio, with Texas also looking in play. Should Democrats gain five seats their majority would not be dependent on Pennsylvania&rsquo;s John Fetterman, a Democrat who often sides with Republicans. This raises the risk of attempts by Trump to manipulate the elections, though it may be difficult for him to do so with elections still largely conducted by the states. However the elections go, they are likely to be accompanied by heated debate and probably significant legal challenges, bringing uncertainty that markets will not welcome. While uncertainty is troubling for markets, its impact on the current impressive strength of business investment is however likely to be modest.<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c18292125ca.jpg" style="width:100%;"></figure>

•    The crisis in the Middle East poses upside risks to headline inflation and downside risks to activity and our baseline assumes a 4-8 week war w

U.S. Outlook: Investment to Lead Growth, Underlying Inflatio

U.S. Outlook: Investment to Lead Growth, Underlying Inflation Set to Slow

Federal Reserve

Long Term Themes

Our Forecasts<figure class="table"><table><tbody><tr><td style="background-color:white">&nbsp;</td><td style="background-color:white">2026</td><td style="background-color:white">&nbsp;</td><td style="background-color:white">&nbsp;</td><td style="background-color:white">&nbsp;</td><td style="background-color:white">2027</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td style="background-color:white">&nbsp;</td><td style="background-color:white">Q1</td><td style="background-color:white">Q2</td><td style="background-color:white">Q3</td><td style="background-color:white">Q4</td><td style="background-color:white">Q1</td><td style="background-color:white">Q2</td><td style="background-color:white">Q3</td><td>Q4</td><td style="background-color:white">2025</td><td style="background-color:white">2026</td><td style="background-color:white">2027</td></tr><tr><td style="background-color:white">Real GDP (%, y/y)</td><td style="background-color:#DDE6EA">4.3</td><td style="background-color:#DDE6EA">4.3</td><td style="background-color:#DDE6EA">4.0</td><td style="background-color:#DDE6EA">4.2</td><td style="background-color:#DDE6EA">4.1</td><td style="background-color:#DDE6EA">4.5</td><td style="background-color:#DDE6EA">4.4</td><td style="background-color:#DDE6EA">4.0</td><td style="background-color:#DDE6EA">4.8</td><td style="background-color:#DDE6EA">4.2</td><td style="background-color:#DDE6EA">4.2</td></tr><tr><td style="background-color:white">CPI (%, y/y, avg)</td><td style="background-color:white">1.2</td><td style="background-color:white">1.9</td><td style="background-color:white">1.7</td><td style="background-color:white">0.6</td><td style="background-color:white">0.0</td><td style="background-color:white">-0.5</td><td style="background-color:white">0.2</td><td style="background-color:white">0.6</td><td style="background-color:white">-0.1</td><td style="background-color:white">1.4</td><td style="background-color:white">0.1</td></tr><tr><td style="background-color:white">7-day reverse repo rate (%, eop)</td><td style="background-color:#E2E9ED">1.40</td><td style="background-color:#E2E9ED">1.40</td><td style="background-color:#E2E9ED">1.40</td><td style="background-color:#E2E9ED">1.30</td><td style="background-color:#E2E9ED">1.30</td><td style="background-color:#E2E9ED">1.20</td><td style="background-color:#E2E9ED">1.20</td><td style="background-color:#E2E9ED">1.20</td><td style="background-color:#E2E9ED">1.40</td><td style="background-color:#E2E9ED">1.30</td><td style="background-color:#E2E9ED">1.20</td></tr></tbody></table></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c149694c777.JPG" style="width:100%;"></figure>Source: Continuum EconomicsThe rebalancing of China&rsquo;s economy more towards consumption remains a slow process, intermittently facing cyclical and structural forces that drag on growth. Key points to note include:&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Iran war a temporary cyclical hit?&nbsp; China imports 4-5mln barrels per day via the Strait of Hormuz and China buyers can only redirect a portion to other oil producers.&nbsp; This means that commercial and strategic stockpiles will likely be used, but they are a huge 1.2-1.3bln barrels of oil (some estimates are higher).&nbsp; Our baseline of a 4-8 week war (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>) is thus not a problem, aside from higher prices with WTI down to USD80-85 by June; USD65-70 end 2026 and USD60 by Q3 2027. We have pushed up our 2026 CPI forecast to 1.4% from 0.5% (higher food prices are also an issue), but as oil/gas prices come down this suggests very subdued 2027 inflation, which we have cut from 0.4% to 0.1% (our forecasts above).&nbsp; However, China is reluctant to run down the strategic oil reserves too much, given the 5yr plan to boost the reserve. Thus a prolonged Iran war would likely see the run-down of the strategic stockpiles being curtailed and cause oil rationing in China, which would adversely impact GDP growth as well as boosting CPI more than our baseline.&nbsp; We would not see major 2nd round inflation effects however, given excess production and labor market slack.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Modest underlying consumer spending. China&rsquo;s authorities are trying to improve the consumer spending outlook by cyclical means (including trade in programs) and structural improvement in safety nets (unemployment/health/pensions).&nbsp; However, the scale for 2026 is modest, with the trade in programs Yuan50bln lower than 2025.&nbsp; The structural safety net improvements are also small for a middle income nation, while China authorities have also not taken up IMF suggestions to improve Hukou benefits for 200mln migrants living in urban areas (<a target="_blank" href="https://continuumeconomics.com/a/624ccac4/china-boosting-consumption-in-march">here</a>).&nbsp; This all likely means that precautionary savings will remain high and not provide a windfall boost to consumption. &nbsp;Without a major government boost to consumption, the consumption growth trajectory will remain modest.&nbsp; Wage growth has slowed noticeably since COVID (Figure 1), while households remain worried about slow employment growth. &nbsp;Additionally, adverse housing wealth effects remain an issue, both impacting consumer sentiment but also seeing households reluctant to borrow (Figure 2).&nbsp; Modest consumption momentum will likely be the story for 2026 and 2027, though still supported by the traditional broadening of services consumption as a middle-income country matures.Figure 1: China Private Sector Wage Growth (Yr/Yr %)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c0eca5aba26.JPG" style="width:100%;"></figure>Source: IMF Article IV Feb 26&nbsp;Figure 2: Domestic Credit To Households (Yr/Yr %)&nbsp;<img src="https://assets.continuumeconomics.com/storage/uploads/69c0ec2c2bb38.png" style="width:100%;">Source: Continuum Economics&bull;&nbsp;&nbsp;&nbsp;&nbsp;Residential property no bottom yet. Official views that the housing market is bottoming appear premature (here). &nbsp;Firstly, a large inventory of complete and incomplete property continues to curtail the interest in new residential construction. &nbsp;Secondly, property developers&rsquo; finances remain volatile, while government support is modest rather than aggressive. &nbsp;Thirdly, households' property optimism has been significantly dented by the bust of the last few years, with some households keen to paydown mortgage debt and meaning domestic credit to households is zero (Figure 2), which only occurs normally in recession or balance sheet constrained economies. Demand remains soft and fragile. Though we see the negative drag from residential property on GDP being less in 2026/27 than 2023/24, it will still knock around 0.75% off GDP in 2026 and 2027. &nbsp;Aggressive local and central government purchases of property would help market clearing and reduce downward pressure on house prices, but the authorities rejected this IMF recommendation in the recent Article IV consultations.&bull;&nbsp;&nbsp;&nbsp;&nbsp;Net exports. &nbsp;A positive contribution should be seen in 2026, but lower than 2025. &nbsp;China was lucky in 2025 in being able to redirect exports to other countries and via 3rd countries to the U.S. &nbsp;The U.S. will continue to tighten China exports through 3rd countries, while the EU and major EM countries want to avoid any cheap dumping by China&rsquo;s manufacturers. Meanwhile, though the October 2025 U.S./China framework deal avoids renewed escalation of trade tension, it is unlikely to be followed by a comprehensive trade deal in 2026 as China does not want major import and bilateral trade commitments. Effective tariff rates are also now not much above the EU/Japan deals after the U.S. Supreme court rejected reciprocal and fentanyl tariffs and the U.S. introduced a flat 10-15% section 122 tariff. &nbsp;&middot;&nbsp;&nbsp; &nbsp;.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; AI/High-tech production/Infrastructure spending. The bright spot for the economy remains AI and high-tech manufacturing, with government support having helped ignite a spending wave in these areas that should be sustained through 2026/27. &nbsp;Open sourced AI applications are more reasonable than U.S. models and this is prompting some transformation. China&rsquo;s manufacturing sector is also aggressively investing in factory robots to replace workers and increase profit margins. March&rsquo;s NPC meeting announced new public sector infrastructure investment for 2026 to try to push GDP growth back up again. A similar modest scale of fiscal easing will likely be seen in the 2027 NPC meeting.&nbsp; &nbsp; &nbsp;Overall, the cyclical headwinds to GDP growth from modest consumption and negative residential property investment remain and net exports will be less of a support.&nbsp; It is also worth mentioning that population aging is more evident on a structural basis, which slows new house demand and absolute consumption levels for the over 55&rsquo;s (<a target="_blank" href="https://continuumeconomics.com/a/45f24688/japan-aging-consumption-lessons-for-eurozonechina">here</a>).&nbsp; The underlying momentum for 2026 looks like 3.8-4.0% -- the Multi week Iran war will likely knock 0.2% off 2026 growth.&nbsp; Though optimists could argue that the AI/tech wave could boost productivity, this is a long-term trend, while humanoid robotics is a 2030s story due to cost and battery problems (<a target="_blank" href="https://continuumeconomics.com/a/b8505498/aihumanoid-robots-and-disinflation">here</a>). The announced fiscal stimulus will likely lift GDP to around 4.2% for 2026. &nbsp;For 2027, we see a further trend slowing to below 4.0%, as the structural headwinds get larger.&nbsp; Even so, further moderate fiscal stimulation will likely come through in 2027 and we forecast 4.2%.&nbsp; It could also be that the reported GDP numbers are higher (to hit the 4.5-5.0% target) than the actual reality, as this still remains the political bias for good news messaging.&nbsp;One consequence of this unbalanced economy and modest consumption growth is that production continues to exceed domestic demand and produce disinflation pressures.&nbsp; Though China authorities are keen to avoid price wars, they will not aggressively push for excess production capacity to be shut as this would provide a vicious adverse circle for China&rsquo;s economy.&nbsp; We forecast CPI at 1.4% in 2026 due to more elevated oil and gas prices throughout the year but 0.1% in 2027 when energy prices come down to pre-war levels.&nbsp;Fiscal and Monetary PolicyThough China&rsquo;s authorities have delivered further fiscal stimulus for 2026, this is modest rather than aggressive.&nbsp; China&rsquo;s authorities feel fiscally constrained by the rapid build-up of government debt/GDP as shown by the main IMF measure (Figure 3) &ndash; the augmented IMF measure that includes the remaining 1/3 LGFV debt is on a still higher trajectory.&nbsp; The general government budget deficit is projected by the IMF to remain in excess of 8% of GDP in the remaining years to 2030.Figure 3: China General Government Debt/GDP IMF Measure (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c0ec3c2139e.png" style="width:100%;"></figure>Source: IMF October 2025 Fiscal Monitor &nbsp;&nbsp;&nbsp;In terms of monetary policy, the authorities&rsquo; action continues to be restrained by concerns that too low interest rates could hurt China&rsquo;s banking system interest margins and lending. Additionally, internal PBOC opposition to ultra-low interest rates and QE remains significant. &nbsp;The 2024 PBOC financial stability review (<a target="_blank" href="https://continuumeconomics.com/a/f1cdf202/chinas-2nd-tier-banking-problems">here</a>) shows only 2% of banking assets in troubled banks, but the 2023 stress tests show this could surge with a 100% pick up in NPLs and lower profitability (<a target="_blank" href="https://continuumeconomics.com/a/f1cdf202/chinas-2nd-tier-banking-problems">here</a>).&nbsp; Cutting policy rates risks hurting margins for weak banks and hurting lending capacity!We still also only see 10bps of reduction in the seven-day reverse repo rate in 2026 to 1.3%. Some further scope exists to cut RRR for big banks but they have better balance sheets than small and rural banks.&nbsp; We see a 50-75bps reduction in the RRR rate in 2026, which will likely also apply to small banks but not rural banks that are already at the 5% floor (Figure 4).&nbsp;Figure 4: Reserve Requirements (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c0ec4835ddf.png" style="width:100%;"></figure>Source: Datastream/Continuum Economics&nbsp; &nbsp;For 2027, we see a further 10bps reduction in the 7 day reverse repo rate, which is restrained by PBOC concerns over the banking system but driven by the need to do something as a signal for the economy.&nbsp; Even so, current low interest rates are not stimulating the private sector, as some households and businesses are facing a balance sheet recession, which would ideally require fiscal policy and market clearing polices to improve confidence.&nbsp;

·       Our baseline scenario of a 4-8 week war (here) is not a problem, aside from higher prices.  We have pushed up our 2026 CPI forecast to 1.4% f

China Outlook: Cyclical and Structural Headwinds

Asia/Pacific

People's Bank of China

Asia Central Banks

Emerging Asia

Andrew Wroblewski

Senior Economist Western Europe

UK, Eurozone

SPAIN

ITALY

FRANCE

·       Under our more likely view of limited further fighting in the Middle East, we see oil and gas prices largely falling back to the pre-war leve

Eurozone Outlook: Conflicts of Interest

European Central Bank

Figure 1: Fed Funds, 2, 10 and 30yr U.S. Treasury Yields Forecasts (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24c3435c32.png" style="width:100%;"></figure>&nbsp;Source: Continuum EconomicsThe U.S. Treasury market prolonged steepening has partially reversed, as 2yr yields pushed up as easing hopes have been tempered due to the Iran war. Our baseline is that the war lasts for 4-8 weeks and does not cause 2nd round effects (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>), but that the economy slows down H2 2026 as consumption has outstripped wage and income growth and fiscal policy is insufficient to lift growth &ndash; AI business investment should ensure this is a soft landing.&nbsp; &nbsp;Kevin Warsh will likely be confirmed as Fed chair and he will pressure for two rate cuts to be delivered, but he is restrained by the majority of voting FOMC voting members being orthodox. Warsh will have to persuade Fed voters to be more forward looking, but also accept his argument that AI will boost U.S. productivity and will be disinflationary (see our recent article <a target="_blank" href="https://continuumeconomics.com/a/0fd5240e/warsh-ai-and-lower-policy-rate">here</a>).&nbsp; This could build an argument for a further cut if the economy softens, though FOMC voters will want to see more evidence on the impact of AI on the economy before reconsidering neutral rate views.&nbsp; This can see one 25bps cut delivered in Q3 and a further move in Q4 &ndash; the latter is a close call, as some FOMC voters could resist. This could also see 2yr down to 3.45% by end 2026, given that the market normally sees a clear swing to a premium of 2yr versus Fed Funds rate in the mature stage of an easing cycle (Figure 2). We see around a 20-30bps 2yr-Fed Funds spread by H1 2027, which is more controlled than the experience at the end of Fed easing cycle in the 1990&rsquo;s (Figure 2).&nbsp;&nbsp;Figure 2: 2yr-Fed Funds Spread and Fed Funds Rate Inverted (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24c411e759.png" style="width:100%;"></figure>Source: DataStream/Continuum EconomicsIn terms of 10yr yields, the 2026 budget deficit will likely be 6.0%, with the supply picture helped by Fed buying in line with nominal GDP (Warsh will find it difficult to get consensus on shrinking the Fed&rsquo;s balance sheet (<a target="_blank" href="https://continuumeconomics.com/a/266ae87b/trumps-fiscal-dominance">here</a>), but he is not on board with Trump&rsquo;s fiscal dominance desires).&nbsp;We also suspect that cyclical economic worries will produce a further yield dip after the Iran war has ended. Additionally, AI disruption is not just a question of winners and losers in the equity market, but some job losses and fear of more job cuts in the future could mean that AI disruption prompts questions over the long-term strength of income/employment and consumption growth (<a target="_blank" href="https://continuumeconomics.com/a/4eeaa851/ai-fed-and-inflation-and-disinflation-risks">here</a>). &nbsp;However, the 10-2yr yield curve tends to steepen further, as a Fed Funds easing cycle gets to a mature stage.&nbsp; The current yield curve is also not steep by 1990&rsquo;s standards (Figure 3) and we can see choppy 10yr yields into H2 2026 (Figure 1) and 10-2yr yield curve steepening to 55-60bps. Given the size of funding requirement; long-term government debt trajectory and political reluctance to undertake fiscal consolidation, 2% 10yr real yields also feel right.Figure 3: 10-2yr U.S. Treasury and Fed Funds Inverted (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24c4da775d.png" style="width:100%;"></figure>Source: DataStream/Continuum EconomicsIn terms of 2027, we see the Fed on hold and fighting any market expectations that a fine tune tightening could occur.&nbsp; This should cap 2yr and 10yr yields (Figure 1) and produce a choppy trading year, though with a small drift up in 2yr yields and yield curve flattening. The odds also remain of the Democrats gaining the House of Representatives, with the Senate now a close call, which will stop any further fiscal easing in 2027-28.In terms of alternative scenarios, the risks are split between a multi-month Iran war that could risk 2nd round inflation effects and stop Fed easing (Figure 4), or a consumption slowdown that produces a domestic harder landing and more Fed rate cuts.Figure 4: 10yr U.S. Treasury Scenario Analysis&nbsp;<figure class="table"><table><tbody><tr><td style="background-color:white; border:1.0pt solid white">&nbsp;</td><td style="background-color:#5A7E94">Baseline&mdash;65%</td><td style="background-color:#556A2C">Upside&mdash;30%</td><td style="background-color:#824A5E">Downside&mdash;5%</td></tr><tr><td style="background-color:white">&nbsp;</td><td style="background-color:#99B2C1">Multi Week Iran War Then Gradual Fed Easing &nbsp;</td><td style="background-color:#A1BF66">Multi Month Iran War &nbsp;&nbsp;&nbsp;&nbsp;</td><td style="background-color:#BC899B">U.S. Driven Harder Landing &nbsp;&nbsp;&nbsp;&nbsp;</td></tr><tr><td style="background-color:#CCCCCC">U.S. Treasuries</td><td style="background-color:#DDE5EA">Fed undertakes 50bps of gradual easing in Q3/Q4 2026, as monthly inflation comes back down after a 4-8 week Iran war has ended. 2yr yields ratchet lower in 2026, but drift up in 2027 on fears of 2028 tightening. &nbsp;Yield curve steepening followed by flattening in 2027.10yr choppy and range-bound yields due to Fed easing versus still large supply from a 6% budget deficit.10yr end 2026 4.00%, end 2027 4.10%</td><td style="background-color:#DFEACC">Iran War last months rather than weeks, which then leads to WTI oil prices towards USD120-180 before coming down to still elevated levels.&nbsp;Headline CPI boost is large leaving a risk of 2nd round effects.&nbsp; Fed cannot cut rates initially, but would also find it difficult to tighten without persistent core PCE rise. &nbsp;However, if the shock caused a recession, then the Fed would cut policy rates to 2% or lower, which would see 2yr yields drop but sharp yield curve steepening.10yr end 2026 4.35%, end 2027 3.90%</td><td style="background-color:#E8D7DD">U.S. economy sees a domestic driven harder landing towards very slow growth, as consumption slows more than expected (weak income growth or AI job disruption) and prompting some disinflation. This scenario also assumes only a 4-8 week Iran war and a fall in energy prices in H2 2026. Fed easing is quicker and potentially to 2.5%.&nbsp;2 and 10yr yields decline more quickly in H2 2026, with some yield curve steepening as the short-end reacts more. &nbsp;&nbsp;10yr end 2026 3.70%, end 2027 3.90%</td></tr></tbody></table></figure>Source: Continuum EconomicsFor Bunds, the Iran war has prompted speculation that the ECB could hike later in 2026 to guard against 2nd inflation effects. However, the March ECB meeting communications (<a target="_blank" href="https://continuumeconomics.com/a/88f67563/ecb-review-not-such-a-good-place">here</a>) were cautious rather than preparing for tightening, as a March-April energy spike will likely only have a temporary impact and the ECB will eventually look through the boost to headline inflation. The upward shift in bond yields and lending rates means the market is already tightening financial conditions without an ECB move. For the ECB council to agree an insurance rate hike will likely be difficult and would likely require a multi-month war and very elevated energy prices.Meanwhile, bank lending intentions and loan rejection rates, alongside still elevated lending rates mean that financial conditions are tighter than suggested by a 2% ECB depo rate.&nbsp; One of the key reasons is that the ECB exit from ultra-easy monetary policy in 2021-22 is still feeding through with a long lag to mean maturing loans face higher rates. Indeed, we still feel that the risk remains for growth momentum to disappoint and as oil and gas prices come down in H2 2026, that the ECB policy debate pivots back to an easing bias or an insurance cut in Q4 2026. &nbsp;We feel it will be a difficult debate, but on balance we look for one 25bps cut to 1.75% given that wage inflation suggests core inflation remains controlled. &nbsp;This likely means a reduction in 2yr Bund yields in H2 2026, given that the market is currently discounting tightening (Figure 5).&nbsp;However, the market will then likely take the view that policy rates have finally bottomed, with some of the hawks likely to voice the view that any such 2026 cut is insurance.&nbsp; Even so, the majority on the ECB will want to maximize the benefit of the monetary policy stance and ECB communications will likely fight ideas that H1 2027 could see tightening.&nbsp; This can limit the traditional swing of 2yr Bund yields to a positive spread over the ECB depo rate in H2 2026/H1 2027 to around 20-40bps, rather than the 60-140bps seen in 2003-05 (Figure 5).&nbsp;Figure 5: ECB Deposit Rate, 2 and 10yr Germany Forecasts (%)&nbsp;<img src="https://assets.continuumeconomics.com/storage/uploads/69c24c64a1414.png" style="width:100%;">Source: Continuum EconomicsOur 10yr Bund yield forecast is for a modest increase in 10yr yields (Figure 5).&nbsp; The German budget deficit expansion will add to bond supply.&nbsp; Additionally, 10yr real Bund yields still remain low relative to the 1990-08 period and we feel that around 3.0% is more appropriate as a medium-term equilibrium. ECB QT also adds to the net bond issuance that the bond market has to digest.&nbsp; The 10-2yr yield curve can steepen to 7-90bps by end 2026, though this is not as steep as 2003-05 (Figure 6) but then into 2027 will likely flatten somewhat.&nbsp; Additionally, as part of the process of improving financial conditions, we also feel that the ECB will slow APP and PEPP QT in 2026 or 2027, which will curtail yield curve steepening.Figure 6: 10-2yr Germany to ECB Deposit Rate Inverted (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24d6257fc0.png" style="width:100%;"></figure>Source: Continuum EconomicsIt is worth mentioning that 2027 could be overshadowed by French fiscal and political tensions.&nbsp; The focus is on the May 2027 presidential elections, where the two stage process means that other major parties will likely rally around a candidate (as yet unclear who this will be) to stop a National Rally candidate winning.&nbsp; However, a new president will be faced with parliamentary deadlock and will therefore face a choice of waiting until 2029 when they are due to hold parliamentary elections or go earlier to try to break the deadlock and get a majority for fiscal consolidation.&nbsp; Current opinion polls suggest that the three way split in the electorate remains and this argues against a post presidential election shift towards fiscal consolidation by any government.&nbsp; Further credit agency downgrades and foreign selling on French government bonds will likely be the result alongside economic sluggishness. At a minimum, fiscal tension throughout 2027 and at worst a H2 2027 French fiscal crisis!&nbsp; It could also mean an 80bps 10yr France-Germany spread. &nbsp;Elsewhere, Italy&rsquo;s PM Meloni will likely be re-elected in October 2027 through with a rejigged coalition but still supporting fiscal consolidation.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Figure 7: 10-2yr JGB to BOJ Policy Rate Inverted (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24d6f7f0d1.png" style="width:100%;"></figure>Source: Datastream/Continuum Economics&nbsp; Figure 8: 10, 2yr JGB and BOJ Policy Rate Forecasts (%)&nbsp;<img src="https://assets.continuumeconomics.com/storage/uploads/69c24c74d38d2.png" style="width:100%;">Source: Continuum EconomicsIn Japan, the Iran war will likely boost 2026 CPI inflation and provide a further reason for a BOJ hike.&nbsp; However, it is the underlying inflation behavior that matters most with higher wage inflation leading to higher CPI multi-year.&nbsp; Our sense is that wage settlements are enough to provide the BOJ with confidence to hike in Q2 and we still feel that April is the most likely date for a hike. Though PM Takaichi appears reluctant to see further BOJ hikes, we feel that the BOJ will want to undertake an additional normalization move. One option is 10bps and 15bps in two steps to see if the oil and gas price shock have any adverse real sector effects. However, on balance we feel that the BOJ will likely go for one 25bps hike and then signal a pause for the rest of 2026 and this could cap 2yr spread over the BOJ policy rate (Figure 8).&nbsp; Though the BOJ could want to normalize further in 2027, we feel that inflation will slow with energy prices coming back down and wage/price setting behavior not establishing inflation around 2% due to wary consumers.&nbsp; Thus we see no change in the BOJ policy rate in 2027 and this can see 2yr yields becalmed.For 10yr yields, the BOJ is the only major central bank that is still increasing the pace of QT, and we estimate that BOJ QT will likely be close to 6% of GDP in 2026. This will likely produce renewed upward yield pressure for longer maturities and we still forecast that 10yr yields could spike to 2.5% and this will likely cause the BOJ to slow the pace of QT by raising the monthly pace of bond purchases rather than reducing it! &nbsp;&nbsp;1st step could come in June 2026, when the BOJ will likely slow or stop the shrinkage on monthly bond buying. This can slow the rise in 10yr yields, but only an increase in bond buying is likely to bring 10yr yields back down to the 2.00-2.25% area.Figure 9: 10, 2yr Gilts and BOE Bank Rate Forecasts (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24c80de9f9.png" style="width:100%;"></figure>Source: Continuum EconomicsFor Gilts, the focus for the next couple of months will be the feedthrough of higher oil and gas prices in the UK, which has clearly delayed easing but the BOE adopted a symmetric neutral policy (<a target="_blank" href="https://continuumeconomics.com/a/dd33a767/boe-review-a-fragile-mpc-truce">here</a>); tightening if 2nd round effects are clear, but easing if disinflation occurs with a slack economy and labor market.&nbsp; Gilts have only heard the tightening risks, which we do not see occurring due to labor market slack and also as financial conditions have tightened with the huge shift in short-end yield and mortgage rates. &nbsp; The BOE need to see the duration of the war, plus the multi month trajectory of oil and gas prices coming back down, which argues for nervous unchanged rates through mid-year. Even so, our central scenario (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>) remains for a 4-8 week war and a partial retracement of energy prices.&nbsp; This could allow the doves on the MPC to revisit the soft UK economy and weak labor market, with the latter arguing against any real 2nd round inflation effects. &nbsp;Indeed, we can see this delivering the next 25bps rate cut in Q4 followed by further slowing easing in 2027.&nbsp; A BOE consensus to raise rates would only likely occur in the scenario of a 2-6 month war that then really threatened 2nd round inflation effects, which is a 30% risk.In terms of 2yr, our BOE view is very divergent from the money and bond markets and this will likely lead to a stepped decline in 2yr yields in 2026 as the market tempers tightening fears and turns more neutral (Figure 9).&nbsp; In 2027, 2yr gilt yields will likely push to a positive premium versus the BOE policy rate, as policy easing gets mature.&nbsp; At the end of the 1994, 1996, 1999 and 2001 easing cycles 2yr gilt yields pushed to 100bps over the BOE policy rate.&nbsp; A positive 25-50bps premium between 2yr and BOE policy rate would be more reasonable now. &nbsp;For 10yr gilt yields, QT is still 2% of GDP. We look for a further slowing to around &pound;50bln from September 2026 to avoid tight financial conditions too much and then &pound;30bln from September 2027 &ndash; while also increasing low T bill issuance.&nbsp; However, politics is a swing factor for gilts in 2026 and 2027 ahead of a 2029 general election, with a high risk that PM Starmer or Chancellor Reeves could be replaced. This would likely lead to a softening of the fiscal rules rather than a major fiscal easing but could temporarily boost 10yr yields (<a target="_blank" href="https://continuumeconomics.com/a/4021ec5a/gbp-foreign-investor-flows">here</a>). &nbsp;&nbsp;Figure 10: 10-2yr and BOE Bank Rate Inverted (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c24e69109ff.png" style="width:100%;"></figure>Source: Continuum Economics10yr gilt yields face a choppy environment in 2026. While our significantly different BOE view versus market expectations argue for a strategic multi quarter decline in yields, UK politics suggests a continued modest risk premium versus U.S. Treasuries.&nbsp; Additionally, the 10-2yr Gilt curve is not steep by historical standards for the level of BOE policy rates (Figure 10) and an easing of BOE tightening fears will likely be mainly seen at the short-end.&nbsp;

·        The multi quarter outlook for DM rates depends on the length of the Iran war Our baseline is that it will be a 4-8 week war (here) and a 3-4

DM Rates Outlook: Mixed Policy Rate and Yield Paths

EMEA

Bank of England

Bank of Japan

Figure 1: 12mth Fwd S&amp;P500 P/E Ratio and 10yr Real U.S. Treasury Yield Inverted (Ratio and %)&nbsp;<img src="https://assets.continuumeconomics.com/storage/uploads/69c1466486830.png" style="width:100%;">Source: Continuum Economics with forecasts to end 2027 for 10yr real bond yields and fwd P/E ratio.The U.S. equity market has traded weaker in Q1 2026 and key forces for the rest of 2026 and 2027 are: &nbsp;&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Iran war. Our baseline (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>) is for a 4-8 week war, USD80-85 by June; USD65-70 end 2026 by June and USD60 by Q32027. This would mean only temporary economic effects, though we now see this delaying Fed easing until Q3 2026. H1 2026 corrective pressures from the Iran war would then be less evident.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Soft Landing. Economic data has been good in H2 2025 and the market expects this picture to be sustained in 2026. However, aggregate whole economy wage growth has been slow, due to low immigration and employment growth. We see consumption slowing in 2026, which can cause some economic concerns.&nbsp; Even so, the U.S. economy can muddle through on an AI Capex boom and balance sheet strength of middle to upper income U.S. households. In 2026, this could all be an excuse for a further modest correction, but nothing greater. We are more nervous about 2027, as the economic cycle will be more mature, mid-term elections will then likely stop any further fiscal stimulation and the Fed will likely have ended easing.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; AI/Tech wave remains but winners and losers. AI semiconductor and hyperscalers are in a modest corrective phase, while the market is also focused on AI losers like software services. However, the AI investment boom continues to be largely financed by cashflow and moderate bond issuance ex Open AI/Oracle, while AI application revenue continues to boom. What is happening is a valuation reset for big tech, and a further 10% could be enough to get fwd P/E ratios for IT and Communications down to levels that have previously attracted real money flows. To get a deeper correction in these sectors would require a significant slowing in exponential AI applications revenue growth, much tighter regulation or a major AI accident (e.g. major cyberattack) - none of which are moderate or high probability in 2026. Core tech could return to support the market later in the year, especially as the rollout of Nvidia Rubin and Groq based LPU chips accelerate AI again. The broader AI story will likely lift productivity and U.S. GDP and produce wider benefits in the next 1-10 years, with the key uncertainty whether this will be modest or moderate (<a target="_blank" href="https://continuumeconomics.com/a/b8505498/aihumanoid-robots-and-disinflation">here</a>).&nbsp;Open AI certainly has stretched finances, but this may come more to a head in 2027/28 when the rate/credit cycle starts to turn rather than in 2026. For 2026, the AI economic and investment wave can still prompt an adverse impact on AI losers in the U.S. economy and cause a derating of select companies that are vulnerable to AI displacement. An interrelated issue is whether AI leads to modest net job losses or large losses, which Fed officials are starting to focus on (<a target="_blank" href="https://continuumeconomics.com/a/4eeaa851/ai-fed-and-inflation-and-disinflation-risks">here</a>). In the worst case, it could widen perceptions of a K shaped economy, but also undermine future U.S. government income tax revenue prospects if heavy job losses are seen and strain fiscal finances. We see this being a 2027-29 story rather than 2026.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Buybacks. If the economy sees a soft landing then buybacks can be counted on to continue at an aggressive pace. A harder landing would likely slow buybacks and amplify a correction, but this is only a 20% probability risk.We are still concerned the U.S. equity market is still overvalued on a broad array of equity valuation measures and also against 10yr real bond yields (Figure 1). If the economy sees a soft landing then 2% real yields are likely to remain in place, which places a strain on the equity market. Meanwhile, peak valuations do not last years but rather months and quarters. 2022 sky high valuations were noticeable from January 2021 to April 2022 before major P/E de-rating occurred. Extremely elevated valuations (CAPE P/E over 40) existed January 1999 to September 2020, before valuations cracked and caused a bear market. &nbsp;A prolonged Iran war would be a major catalyst, but we attach a 30% probability to this alternative scenario that could knock the S&amp;P500 down to 5500-6000. &nbsp;&nbsp;Our baseline for 2026, we feel is for a 5-10% correction driven by the Iran war and consumption slowing to lower wage growth, before a H2 2026 rebound on Fed easing that brings the S&amp;P500 to 7200 by the end of 2026.&nbsp;In terms of 2027, job losses from AI could be more noticeable and cause a fear factor among consumers that dent consumption and growth. The economic cycle will be more mature. This risks a new deeper correction in the overvalued U.S. equity market. We then see a recovery to 7000 by year-end 2027.&nbsp;Figure 2: Germany/UK 12mth Earnings Yield minus 10yr Real Government Bond Yield (using 10yr breakeven inflation)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c14676e3283.png" style="width:100%;"></figure>&nbsp;Source: Continuum Economics. Continuum Economics projections until end-2027 using 10yr breakeven inflation and Bund/Gilt yield forecasts.&nbsp;EZ equities have retraced with the Iran war given its energy import dependency, but a 4-8 week war should provide some energy price relief in H2 relief and only temporary economic effects (the alternative of a 2-6 month Iran war would deepen the correction in EZ equities, especially if further damage were seen to Qatar LNG facilities). This can allow a refocus on the fundamentals in H2.&nbsp; EZ has seen the worst of Trump tariffs, as he becomes more constrained by the Supreme Court and voters cost of living concerns &ndash; we also see an eventual negotiated settlement on Greenland (<a target="_blank" href="https://continuumeconomics.com/a/942327fc/europe-nuclear-weapons-nato-and-greenland">here</a>). However, corporate earnings have been trimmed on the margin, which reflects only a modest economic recovery. Though Germany is being helped by a cyclical recovery and extra fiscal spending on defense and infrastructure, France restrained by an adverse budget deficit and political splits &ndash; Italy is also fiscally restrained by multi-year fiscal consolidation needs. Spain is a bright spot, but is past its cyclical peak.&nbsp; &nbsp;&nbsp;Equity-bond valuation for EZ equities are better than the U.S., but Germany is now tight relative to post GFC history (Figure 2) and the 12mth fwd P/E ratio is now just back to fair value. We do not see the ECB hiking due to economic slack and already tight financial conditions. Though we look for one further 25bps cut from the ECB in Q4 2026, this is not enough in itself to see EZ equities clearly outperforming. Finally, any Ukraine peace deal will likely not arrive until into 2027, while the EZ/EU remain reluctant to get addicted to cheaper Russian gas again. This all means that EZ equities do not have a clear new positive story to further outperform U.S. equities in the next 9 months, apart from portfolio diversification away from the U.S. We see no renewed outperformance versus the U.S. in 2026. 2027 will likely see ongoing EZ economic recovery which can help EZ equities mildly outperform the U.S, as we are negative on the U.S. Even so, the French fiscal mess will likely come into sharper focus as the May 2027 presidential election looms, but the prospect is that the equally important parliamentary election may not occur before 2029.Figure 3: Japan 12mth Earnings Yield and 10yr Nominal Government Bond Yield (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c147415e2ab.png" style="width:100%;"></figure>Source: Datastream/Continuum Economics. UK real yield uses RPI instead of CPI.Japan&rsquo;s equities had a great couple of months helped by Takaichi achieving a majority in the 2nd election before the Iran war prompted profit-taking. However, with optimism that corporate reforms will boost returns on equity and NISA savings boom, this has still left the market slightly overvalued. 2026 corporate earnings growth estimates have started to be trimmed, as 2-3% nominal GDP growth restrains actual earnings.&nbsp; Additionally, though we only see one further 25bps BOJ hike in 2026, we do not see the BOJ QT acceleration stopping until an accident occurs in the JGB market from the huge supply pressures. This could happen by mid-2026, which would likely see a BOJ partial U turn on QT and a pause in further BOJ policy rate hikes. This could mean that the remainder of 2026 sees volatile trading and underperforms the U.S. However, 5% outperformance can be seen in 2027, with a weaker U.S. equity market and a steady BOJ leading to a refocus on still favorable equity-bond yield relatives (Figure 3). A sharp rebound in the extremely undervalued JPY could, however, hurt the market for multiple months. &nbsp;A 2-6 month war in our alternative scenario would mean a deeper correction in the coming months.Re UK equities, the FTSE 100 has held up better than the U.S. so far in 2026, helped by commodity optimism.&nbsp; Though the Iran war has stopped BOE easing hopes, we do not see the BOE hiking due to a weak labor market.&nbsp; Additionally, our baseline is for a 4-8 week war and inflation fears to reverse in H2.&nbsp; This can help UK equities, though the market looks overdone on commodities as a driver. Additionally, UK mid-term political turbulence will likely reach new heights after the May local and Scottish elections, with a real risk of a softening of the UK fiscal rules (<a target="_blank" href="https://continuumeconomics.com/a/f0693e7d/uk-gilt-vigilantes-and-politics">here</a>). This could mean mild underperformance versus the U.S. in 2026.&nbsp; 2027 can see the UK outperforming by around 5%, but by the market standing still and the U.S. equity market going down.Overall, other DM equity markets will likely not outperform U.S. equities in 2026 and 2027, as less stretched valuations are offset by domestic economic and fiscal issues.&nbsp;Emerging MarketsChina&rsquo;s equity market needs a new catalyst, but the March NPC fiscal stimulation was modest rather than aggressive (<a target="_blank" href="https://continuumeconomics.com/a/66db7633/china-45-50-gdp-growth-for-2026">here</a>) and the Iran war hurting GDP momentum and prompting a modest correction. Combined with a reluctance to ease monetary policy for fear of hurting bank margins, the stimulus is providing support to avoid an economic slowdown rather than speeding up growth. Consumption remains modest due to adverse wealth effects from the housing market and weak consumer confidence as wage and employment growth remains weak. Add in the ongoing multi-year drag from residential property and the China non AI/high tech manufacturing sector faces headwinds. A U.S./China comprehensive trade deal would be a positive catalyst, but this now looks to be only a 20% probability in the next 2 years, as Trump&rsquo;s Supreme Court defeat reduces the incentive for China to strike a deal &ndash; though China authorities will want to keep the trade truce to avoid section 301 sanctions by the U.S. We expect nominal GDP of around 5.0% in 2026, which suggests that 2026 corporate earnings estimates will be trimmed as the year goes on. Meanwhile, though China tech is making progress with cost effective AI solutions, U.S. AI models will open a gap in the next 6-18 months with Nvidia Blackwell and Rubin chips that are not available in China. Finally, valuations are no longer cheap in equity terms or against real government bond yields (Figure 4), though some are looking at earnings yield-nominal government bond yield spreads to support the market. China&rsquo;s 2026 corporate earnings growth can push the market higher, but without further P/E multiple expansion. Our baseline is a for 4-8 week Iran war and China will likely see similar gains to the U.S. in H2 2026.2027 can see a 2.5-5% outperformance versus the U.S., but driven by tech &ndash; though given our U.S. equity call, this means the index going sideways. Non tech is slightly overvalued, and will still face the challenge of modest consumption and the ongoing residential property bust, alongside a profit margin squeeze from excess of production over domestic demand.Figure 4: China Earning-Bond Yield Relative Cheap Compared to Other Big EM&rsquo;s (%)&nbsp;<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c1469b0852b.png" style="width:100%;"></figure>Source: Continuum Economics. CAPE Earnings Yield-10yr Real government bond yieldIndia&rsquo;s equities underperformance has grown on Rupee weakness and Iran war energy shock. We expect the latter to reverse through the remainder of 2026 on a 4-8 week war baseline, but a modest rebound is only likely in H2 2026 &ndash; a 2-6 month war is a 30% alternative scenario and could cause a further 10% index decline given India&rsquo;s energy dependency. Market valuation is less overstretched but still above multi-year fair value measures, while India&rsquo;s equity to bond yield spread is now modestly unfavorable (Figure 5). Concerns are also growing that India&rsquo;s IT services sector could become a net AI loser. However, solid 15% 2026 corporate earnings growth expectations should help the P/E derate further, but also allow enough for a H2 2026 rally and we only see scope to outperform U.S. equities by 2.5% by end 2026. 2027 should be better for India&rsquo;s equities in absolute terms, as corporate earnings feed more into market levels and less into multiple deratings, and we see 10-15% outperformance versus the U.S.Figure 5: India 12mth Fwd Earnings Yield-10yr Nominal government Bond Yield (%)&nbsp;<img src="https://assets.continuumeconomics.com/storage/uploads/69c146aa6be19.png" style="width:100%;">Source: Datastream/Continuum Economics.Brazil has fallen alongside the global equity market amid economic fears from the Iran war, but our baseline is for a 4-8 week war and this should stabilize the market in Q2 - but what happens then? Brazil&rsquo;s equities outperformance in January and February, had been helped by commodity prices and hopes of BCB easing in the coming quarters driving the fwd P/E higher. Given the relationship between 10yr yields and the fwd P/E ratio, a further rerating will likely be evident over the next 18 months. However, the BCB easing will likely remain modest, while the bond market will also remain concerned about fiscal policy ahead of an expected close presidential election in October 2026. Additionally, earnings growth has been trimmed as ultra-tight monetary policy feeds into economic slowdown and earnings rebound looks like a 2027 rather than 2026 story. We can see no outperformance versus U.S. equities for the remainder 2026 if Lula wins the presidential election, but 5-10% if Flavio Bolsonaro wins &ndash; all a Q4 story. &nbsp;Late 2026 and 2027 should then be better, with consistent BCB easing helping to bring down yields and allowing a fall in fwd earnings yields that sees the price/earnings ratio moving above 12. 10-15% 2027 outperformance versus the U.S. should be on the cards. &nbsp;&nbsp;

·        For global equities, our baseline (here) is for a 4-8 week Iran war, with WTI down to USD80-85 by June; USD65-70 end 2026 by June and USD60 

Equities Outlook: Navigating Cyclical and Structural Forces

Latin America

Continuum Daily

SAUDI ARABIA

Oil markets in 2026 have been extremely volatile due to the conflict in Iran and disruptions in the Strait of Hormuz. Under our baseline scenario of a

Commodities Outlook: The War in Action

AMERICAS

ASIA

Commodities-Commentary

EMERGING MARKETS

TAIWAN, PROVINCE OF CHINA

Our Forecasts<figure class="table"><table style="background-color:#E7E6E6"><tbody><tr><td>&nbsp;</td><td>GDP Growth</td><td>&nbsp;</td><td>&nbsp;</td><td>Inflation</td><td>&nbsp;</td><td>&nbsp;</td><td>Policy Rate&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td>&nbsp;</td><td>2025</td><td>2026</td><td>2027</td><td>2025</td><td>2026</td><td>2027</td><td>2025</td><td>2026</td><td>2027</td></tr><tr><td>Australia</td><td style="background-color:white">1.9</td><td style="background-color:white">2.2</td><td style="background-color:white">1.8</td><td style="background-color:white">2.8</td><td style="background-color:white">3.1</td><td style="background-color:white">2.1</td><td style="background-color:white">3.60</td><td style="background-color:white">4.35</td><td style="background-color:white">4.1</td></tr><tr><td>India (FY 25/26/27 for GDP)</td><td>7.3</td><td>6.4</td><td>6.4</td><td>2.1</td><td>4.1</td><td>4.2</td><td>5.25</td><td>5.25</td><td>5.25</td></tr><tr><td>Indonesia</td><td style="background-color:white">5</td><td style="background-color:white">4.8</td><td style="background-color:white">4.8</td><td style="background-color:white">1.8</td><td style="background-color:white">2.9</td><td style="background-color:white">2.3</td><td style="background-color:white">4.75</td><td style="background-color:white">4.75</td><td style="background-color:white">4.5</td></tr><tr><td>Malaysia</td><td>4.7</td><td>4.6</td><td>4.4</td><td>1.9</td><td>2.7</td><td>2.0</td><td>2.75</td><td>2.75</td><td>2.75</td></tr></tbody></table></figure>Source: Continuum EconomicsRisks to Our Views<figure class="table"><table style="background-color:#E7E6E6"><tbody><tr><td>&nbsp;</td><td>Risk&nbsp;</td><td>Probability&nbsp;</td><td>Impact</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td>Upside</td><td style="background-color:white">Iran war settlement cause quicker reduction in energy prices than our baseline.&nbsp; &nbsp;&nbsp;</td><td style="background-color:white">Low to Medium</td><td style="background-color:white">Medium</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td>Structural reform efforts gain traction and enables strong medium-term Asia growth.</td><td>Low to Medium</td><td>Medium</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td>Downside</td><td style="background-color:white">2-6 month war leads to energy prices surge up to demand destruction levels of USD120-180.&nbsp; Regional economies CPI surge threaten 2nd round effects and temporary policy tightening.&nbsp; GDP Growth also hit. &nbsp;</td><td style="background-color:white">Medium</td><td style="background-color:white">High</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td style="background-color:white">Trump administration gets aggressive on new tariffs, which cause 2026 trade tensions and export hit &ndash; very low probability, while Iran war elevates energy prices.</td><td style="background-color:white">Low</td><td style="background-color:white">Medium</td><td>&nbsp;</td><td>&nbsp;</td></tr><tr><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td><td>&nbsp;</td></tr></tbody></table></figure>Source: Continuum EconomicsIndiaThe Iran war economic effects at least hit at a time when India had been enjoying a Goldilocks period of good growth and controlled inflation. Even so, our baseline of a 4-8 week war means that we have to revise down the GDP outlook slightly to 6.4%, as the government cannot fully protect the economy from the supply disruption. Oil imports are also 3.1% of GDP, which means higher costs will likely hurt other domestic spending. India has already switched some oil purchases towards Russia, with April orders of 60mln barrels double the February figure, but at a USD5-15 premia to Brent prices. Though price controls and subsides will curtail the initial impact of higher oil prices, we have also revised up our 2026 CPI forecast to 4.1%.The lower effective trade tariffs from the U.S. (10% with section 122 rather than the higher reciprocal tariffs), will continue to feed through and help CPI.&nbsp; Meanwhile, core inflation at 4% was controlled before the Iran war.&nbsp; Even so, higher cooking oil prices will feed through quickly, while LNG is a headache.&nbsp; Though India has only about 5 days of strategic oil reserves it can redirect oil purchases from other countries. The problem for LNG is that alternative providers are also seeing strong demand from Japan/S Korea and Taiwan, which is keeping Asia gas prices high and supply tight. &nbsp;Meanwhile, nitrogen fertilizer prices have surged as the Middle East is a big supplier via the Straits of Hormuz and India is a large importer of Urea and other Nitrogen fertilizers. This can have a direct effect on food prices later in 2026, which could be amplified if India farmers reduce use of nitrogen fertilizer and then crop yields turn out to be lower than previous projections! &nbsp;&nbsp;This is an upside risk to our 2026 inflation forecast.The RBI has to navigate these challenges.&nbsp; We expect the RBI to not hike the policy rate on our view that oil and gas prices will come back down later in 2026. The RBI has a dovish bias, which was evident in February where 2 members were building the case for easing.&nbsp; Easing is no longer on the cards, but a high bar exists for a hike.&nbsp; The RBI will likely expect limited 2nd round effects, as the situation is different from 2022 when the Ukraine oil price spike came against a buoyant post COVID demand picture. Additionally, non-energy and fertilizers goods are not impacted by the global supply disruption seen in 2022 and China is currently keen to export globally. &nbsp;The RBI initial guidance in the latest state of the economy report was also to emphasize the resilience of the Indian economy.&nbsp; Some words of caution should be seen from the April 8 RBI meeting, but we do not expect this to translate into any rate hikes in 2026.&nbsp;Meanwhile, though the India Rupee (INR) has depreciated since the start of the Iran war, the direct impact on inflation is moderated by the closed nature of India&rsquo;s economy.&nbsp; The indirect psychological effect on INR depreciation is a potential inflation issue, given the overemphasis on the INR in the media.&nbsp; However, the RBI has large FX reserves, which we expect them to continue to use in the acute war stage and we see a managed depreciation through the remainder of 2026 to the 95.50-96 area on USDINR.&nbsp; A rate hike for INR weakness is not likely, as the RBI FX reserves are large enough and foreign investors have already cut India asset holdings substantively in the past 15 months. &nbsp;Figure 1: India CPI, Policy Rate (% change, yr/yr)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c4daff0a241.png" style="width:100%;"></figure>Source: Datastream/Continuum EconomicsA crucial assumption is that the Iran war lasts 4-8 weeks.&nbsp; Figure 2 shows our forecast for WTI prices in the remainder of 2026 and 2027 and contrast that with the profile of WTI through the early stages of the Ukraine war from 2022 and 2023.&nbsp; We see oil prices coming down by Q2 with the end of a 4-8 week war, which is a short duration than the 2022 Ukraine war.&nbsp; This is helpful as India energy subsidies act as a buffer and reduce feed through to hurt growth and boost CPI.&nbsp; It is also worth noting that LNG gas prices are nowhere near as high as the Ukraine war, as 2% of global gas is shipped through the Straits of Hormuz versus 20% of global gas cut off during the Ukraine war.&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp; A 2-to-6 months Iran war can spike WTI to USD 120-180 (depends on duration and further damage) and remain elevated for the remainder of 2026 &ndash; see Figure 2. This would prompt a stagflation hit to the global economy; and in some cases prompt modest to moderate rate hikes in Asia to lean against 2nd round inflation effects. &nbsp;For India, this is a worse oil shock than the Ukraine war, which would knock 1% off our 2026 GDP forecast and boost CPI inflation to 6-7%.&nbsp; A dovish RBI would be forced into temporary rate hikes of 50-100bps to guard against 2nd round effects, but then look to reverse in 2027.&nbsp;Figure 2: WTI Oil Price Including CE Forecasts (USD)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c4daf42599c.png" style="width:100%;"></figure>Source: Continuum EconomicsIndonesiaThe Iran war comes at a difficult time for Indonesia.&nbsp; The rating agencies are already upset with signs of fiscal slippage and concerns that the 2003 3% limit on the budget deficit could be broken by populist programs (free school meals and welfare programs). &nbsp;Now energy subsidies are being put under pressure by the elevated oil prices.&nbsp; The government will try to cushion the economy from the effect of the high energy prices, but we would suspect that the threats of rating agency downgrades could mean that this is somewhat less than would normally occur.&nbsp; This means that the feedthrough of energy prices to hurt GDP growth could be somewhat more than in government forecasts of 5.3% 2026 GDP growth and we have revised down our GDP forecast to 4.8%.&nbsp; Even so, Indonesia is a modest net oil importer, but exports coal and this means the direct hit from supply disruption should be small on GDP.&nbsp; However, we keep 2027 at 4.8%, as our baseline of a 4-8 week war and then reversing energy prices should help support 2027 growth.2026 CPI inflation is being revised upwards from 2.0 to 2.9% due to the energy price shock, but we have revised down 2027 CPI from 2.5% to 2.3% as energy prices reverse.&nbsp; The 4.8% CPI figure in February will unwind in March, as February was distorted upwards by adverse base effects.&nbsp; Even so, inflation could push above 3% Yr/Yr into the spring.This provides a dilemma for Bank Indonesia.&nbsp; Before the Iran war, BI was looking for an opportunity to cut interest rates to support growth.&nbsp; However, with the 2026 pick-up in inflation and the Indonesia Rupiah weak it is difficult to see the BI cutting in 2026 &ndash; MSCI is also threatening to shift Indonesia from emerging to frontier status, which would dent foreign investor flows. Nevertheless, if a 4-8 week war is seen and energy prices reverse, then we feel a window of opportunity should open in 2027 for BI and we look for a 25bps cut to 4.25%. &nbsp;Healthy FX reserves means that BI can manage currency pressures in the near-term.Figure 3: Indonesia CPI, Policy Rate (% change, yr/yr)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c4dae823d1a.png" style="width:100%;"></figure>Source: Datastream/Continuum EconomicsIn the alternative scenario of a 2-6 month war and USD120-180 oil prices, Indonesia would be under severe pressure.&nbsp; This would be a worse oil shock then the Ukraine war and would threaten to boost annual inflation outside of BI 1.5-3.5% inflation target. Headline CPI could spike to 5-6%, which would likely force BI to undertake 50-75bps of hikes to guard against 2nd round effects.&nbsp; The adverse GDP hit would also be greater, as limited fiscal space would mean that the government could not provide large subsidies against the energy shock.AustraliaThe RBA underwent a decisive shift in the first quarter of 2026 as they raised the official cash rate for the second consecutive month, bringing it to 4.1%. This was a narrow 5&ndash;4 split decision that reflected a change toward an active stance in response to geopolitical energy shock and rising underlying inflation. The hawkish pivot from before the escalation of conflict in the Middle East, which disrupted global shipping and pushed energy prices significantly higher. This external shock has complicated the inflation path just as the base effects from the expiration of government energy rebates began to take effect. While headline inflation held steady at 3.8% in January, the&nbsp;trimmed mean CPI edged up to 3.4%, signalling that underlying inflation is more entrenched now. The RBA Board noted that while some of these factors are transitory, the risk of inflation remaining above the 2&ndash;3% target band for a prolonged period was too high to ignore.The domestic demand resilience seen throughout 2025 has begun to show cracks under the weight of negative real wages. Although the Wage Price Index remained solid at 3.4% y/y, it continues to lag headline inflation. This has turned Australian' consumers head towards a higher household saving ratio (from 6.1% to 6.9%&mdash; highest level since September 2022). We have revised 2026 GDP lower to 2.2% and 2027 at 1.8% accordingly, also factoring in tighter fiscal policy from the RBA.Investment has become another pillar of the Australian economy, specifically within the digital and green energy sectors. Private investment grew significantly in late 2025 and remains firm in early 2026, led by a massive wave of capital expenditure in AI-ready data centers. These are being paired with significant public investment in renewable energy zones and water infrastructure.Looking forward, the trade outlook is volatile from ongoing geopolitical tension. While LNG prices have spiked alongside oil due to physical disruption, iron ore export is relatively steady supported by Southeast Asian and Indian demand. This could potentially be a boom for exporters and bane for Australian residents.The RBA has taken a hawkish stance in the March meeting. They are seeing the service sector continuously driving inflation higher, given the current solid labor market (4.3% unemployment). Our forecast for 2026 CPI is revised higher to 3.1% and 2.1% for 2027, to reflect the inflationary impact from the Middle East chaos and then the unwind helping subdue inflation in 2027. We are only seeing one more 25bps hike from the RBA in the May meeting to 4.35%, unless geopolitical tension persists longer than our central forecast of a 4-8 week war. Figure 4 shows that policy is already restrictive in contrast to the start of 2022. If we do see a 2-6 month war then, we could see another 25bps hike from the RBA to curb the red hot inflation.Figure 4: Australia CPI, Policy Rate (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c4dadccde4e.png" style="width:100%;"></figure>Source: Datastream/Continuum EconomicsMalaysiaThe surge in oil prices due to the Iran war has prompted an upward revision in our 2026 inflation forecast to 2.7% from 2.0%, as oil and gas prices feed into the economy.&nbsp; Nevertheless, a 4-8 week war is unlikely to produce 2nd round effects and as energy prices come back down in H2 2026 and H1 2027, the monthly inflation numbers should be better controlled again. We are thus reducing the 2027 CPI forecast from 2.5% to 2.3%.&nbsp;The real sector should not be impacted.&nbsp; Firstly, though Malaysia is a modest net oil importer, it is a net exporter of LNG and this will find plenty of buyers.&nbsp; The external energy balance is thus unlikely to deteriorate. Elsewhere, the Malaysian economy continues to benefit from the AI boom, with semiconductor demand strong and order books healthy well into 2027. This should also support the economy. &nbsp;This leaves us inclined to keep the existing 2026 and 2027 GDP forecasts.&nbsp;Central bank policy will also likely remain unchanged on a 4-8 week war scenario, as BNM will expect the 2026 CPI pick up to reverse in 2027. On the external side, the Malaysian Ringgit has actually remained strong against the USD, despite the USD bounce on the Iran war.&nbsp; The market appreciated that favourable energy position for Malaysia and also its AI and tech exposure and this is keeping the currency well underpinned, despite policy rates being lower than the U.S. The currency is thus also comfortable for the BNM and we see the policy rate remaining at 2.75% throughout 2026 and 2027.&nbsp; &nbsp;

·       The Iran war macro impact on Asia depends on length of the conflict and impact on energy flows. Our baseline is for a 4-8 week Iran war, with

Asia/Pacific (ex-China/Japan) Outlook: The Iran War Shock

Bank Indonesia

Reserve Bank of Australia

EM-EMEA

Macro Newsletter

Reserve Bank of India

Bank Negara Malaysia

<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c20a8c48746.png" style="width:100%;"></figure>&nbsp;<h3>Macroeconomic and Policy Dynamics</h3><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c20adbd272a.png" style="width:100%;"></figure>&nbsp;Private consumption growth steadies as real wages turned positive since the beginning of 2026, ending the prolonged choppy period. After the initial shock of U.S. trade tariffs fades, the early Shunto (spring wage) negotiations are yielding positive result. This momentum confirms that the cycle of higher business price/wage setting is resilient, providing the necessary floor for steady consumer behavior throughout 2026.PM Takaichi&rsquo;s JPY 21.3 trillion stimulus is fully in motion. One-time measures, including the energy subsidies (JPY 7,000/household) and rice coupons, are currently active in Q1 2026. The measures have been extended throughout Q2 to offset the living cost pressure from high global oil prices. The 10-year strategic fund for A.I. and chips has also been officially integrated into the FY2026 budget, reinforcing Japan&rsquo;s long-term industrial competitiveness and hoping to attract more business investment. Takaichi's fiscal policy remains pro-spending but so far seems disciplined. Our projection of a 0.9% increase in government spending for 2026 sees Takaichi balancing strategic investment &amp; cost relief with the need to secure market confidence.The trade balance remains under pressure from U.S. tariffs but the diversification strategy is yielding results. The stable growth in exports to Asia and the EU since late 2025 is helping to cushion the manufacturing sector. While the weak JPY keeps Japanese exports attractive, we expect net exports to moderate in 2026/27 as strengthening domestic demand and higher energy costs drive imports higher. The soft JPY maybe here to stay a bit longer unless we see strong commitment from the BoJ or USD haven bids fade on geopolitical tension easing.&nbsp;<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c20bb978f07.png" style="width:100%;"></figure>&nbsp;Our forecast for 2026/27 GDP is revised to +1.0% as wage/price setting and consumption behavior are firmly in motion with private consumption the cornerstone. The "Takaichi stimulus" has been partially neutralized by high energy prices and will be contributing less towards previously anticipated economic growth. The 2026 preliminary "Shunto" results have passed even the most optimistic expectation. Major firms (including Nissan and Mitsubishi Motors) have fully accepted union demands, with average hikes landing between 5.5% and 5.9%. In the BoJ&rsquo;s eyes, these consecutive years of 5%+ hikes confirms that the structural change in wage-setting is now a permanent feature of the Japanese macro-landscape, anchoring inflation sustainably toward the 2% target. With average household spending in 2025 at +1.5% y/y, we are forecasting solid consumption growth in 2026 when real wage accelerates.Although rice prices have mostly stabilized due to the 2025 harvest, the less fresh food &amp; energy CPI has remain a tough nut to crack. We have further revised 2026 CPI to 2% to account for the recent energy price volatility driven by Middle East tensions. For 2027, our central forecast is 1.6% to address the fade out of cost-push element and demand-pull inflation takes over.&nbsp;&nbsp;<h3>Policy Outlook</h3>&nbsp;The BoJ&rsquo;s rhetoric remain committed to further tightening if the 2% sustainable inflation outlook holds. Following the March 19 hold at 0.75%, we still anticipate a 25bps hike to 1% in April. The Middle East conflict may give BoJ second though yet the current adverse GDP impact is not sufficient to stall their hike. While PM Takaichi&rsquo;s pro-spending stance creates political obstacle, the strong wage growth gives the BoJ enough cover to ignore political headwinds for one hike. However, moving beyond 1% remains outside our central scenario, as SMEs still struggle to pass on the full weight of higher borrowing costs and 2027 inflation will likely come in below BOJ forecasts.10-year yields have been on a "one-way traffic" since PM Takaichi took office, recently testing 2.24%. Fiscal concerns regarding the JPY 21.3 trillion stimulus is the primary driver alongside QT at close to 6% of GDP. We maintain that the BoJ will allow yields to grind higher but view 2.5% as the "line in the sand&rdquo;. If yields jump too fast toward this level, we expect the BoJ to deploy emergency bond-buying operations to intervene and also scale down QT by stopping the reduction in monthly bond buying or actual increasing.&nbsp;We maintain our forecast for no change in the BoJ policy rate in 2027. Once the 1% terminal rate is reached in April 2026, the BoJ will likely enter a prolonged "hawkish hold" to allow the economy to digest the higher interest rate environment, to balance between domestic demand and QT.&nbsp;

•    Private consumption is supported by real wage turning positive in 2026. The trend is solidified by early spring wage negotiation results, which

Japan Outlook: A Perfect Window

NORWAY

·       In the UK, even without the Middle East impact we were suggesting a sub-consensus 2026 GDP picture which now has even greater downside risks 

Western Europe Outlook: Economies Slip on Oil

Norges Bank

Swiss National Bank

Riksbank

RUSSIAN FEDERATION

·     In South Africa, we foresee average headline inflation will stand at 3.8% and 3.5% in 2026 and 2027, respectively based on our baseline of a 4-

EMEA Outlook: Adverse Global Developments and Domestic Uncer

EMEA Outlook: Adverse Global Developments and Domestic Uncertainties Dominate

EM-EMEA Central Banks

Central Bank of the Republic of Turkey

South African Reserve Bank

Central Bank of Russia

Figure 1: Energy trade, measured as the percentage of energy use (-ve is net importer, +ve net exporter)&nbsp;<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c10fdc5281f.png" style="width:100%;"></figure>Source: World Bank (2023 data), CEFor global FX our baseline (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>) is for a 4-8week Iran war, with WTI down to USD80-85 by June; USD65-70 end 2026 by June and USD60 by Q3 2027. &nbsp;A fragile situation will mean it will take until 2027 for energy prices to return to pre war levels. This would mean only temporary economic effects and a refocus on underlying cyclical and structural forces. However, the Iran war and post war energy price trajectory has interrupted the USD downtrend and prompted a bounce on safe haven flows and tempering of Fed easing expectations. &nbsp;Additionally, the U.S. energy self-sufficiency stands in sharp contrast to the EZ/Japan dependence on imports energy (Figure 1). &nbsp;For EUR/USD, the memories of the Ukraine war energy crisis in Europe have reawakened, when a super surge in natural gas prices rocked European industry and households much more than the U.S. This prompted a fall below parity on EUR/USD and a detachment from 10yr bond yield differentials (Figure 2). While the EUR is vulnerable to a prolonged multi month war this is not our central scenario, while it is also worth noting that natural gas through the Straits of Hormuz is 2% of global consumption (LNG is 10% of global natural gas) compared to approximately 20% of global oil consumption through the Straits. This is less of a natural gas shock to Europe than the Ukraine war. Thus we are not overly pessimistic on the EUR, despite what will likely become a fragile situation after hostilities end. &nbsp;As energy prices ratch down through the course of 2026 we would see the EUR starting to recover ground on this understanding that the economic hit is temporary. &nbsp;Additionally, 10yr Bund yields has narrowed structurally versus the U.S. with Germany huge defense and infrastructure spending kicking in throughout 2026. We can see EUR/USD returning to 1.20 by end 2026. &nbsp;For 2027, we generally feel that the overvalued USD will continue to unwind &nbsp;as part of a multi-year cycle and we can see EUR/USD at 1.24 by end 2027. &nbsp; &nbsp;Figure 2: &nbsp;EUR/USD and the 10 year US/Germany yield spread<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c110090f8fc.JPG" style="width:100%;"></figure>Source: Datastream, CEIn our December Outlook, our favorites were the AUD and NOK, which were rerated noticeably against the USD in January and February, before the Iran war bounce for the USD. AUD and NOK of course are beneficiaries from the more elevated energy prices (Figure 1) and long-term energy investment could be reignited by a desire to diversify away from the Gulf and the Straits of Hormuz. &nbsp;Our primary reason for AUD and NOK also still holds in the context of yield spreads. &nbsp;The RBA is expected by the market to tightening by a further 50bps this year, as it leans against domestic inflation and a tight labor market. &nbsp;Given our view that the March USD bounce should recede later in the year as energy prices come down, we still forecast 0.72 for end 2026 on AUD/USD. &nbsp;However, we did note in December that the AUD is also attractive on a cross-rate basis as well and Figure 3 shows room exists for a rerating against the EUR. &nbsp;GBP/AUD also looks ripe for a rerating, as a slack UK labor market and the recent tightening in UK financial conditions will likely mean that the BOE does not actually hike rates. &nbsp;Additionally, though the FX market has not normally differentiated between government debt sinners and saints, Australia government debt trajectory gives it fiscal space that does not exist to the same degree in the UK or the U.S.&nbsp;Figure 3: EUR/AUD and 10 year yield spreads<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c1104d46d0c.JPG" style="width:100%;"></figure>Source: Datastream, CEThe NOK also is a fiscal saint thanks to the windfall of oil and gas revenue. &nbsp;The uprating of the NOK can return later in the year as the Iran war tensions ebb and an reassessment of remaining NOK undervaluation comes through. &nbsp;The Norges bank policy rate level also stands above most other DM countries, which is helpful and we see NOK as a high yield safe haven. &nbsp;In December, we highlighted NOK/SEK as one way to play for this NOK reassessment and Figure 4 suggest that we still have scope for NOK appreciation. On EUR/NOK we also look for renewed appreciation to 11.00 by end 2026.&nbsp;Figure 4: NOK/SEK and 10 year yield spreads<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c1107a22de1.JPG" style="width:100%;"></figure>Source: Datastream, CEJPY still has the most scope for gainsQ1 saw the JPY weaken again after the Lower House election strengthened Takaichi and the LDP and fueled expectations of a return to &ldquo;Abenomics&rdquo; &ndash; involving both easier fiscal and monetary policy. However, while Takaichi has passed an expansionary budget, it is not substantially different from previous budgets. &nbsp;Additionally, though the PM has tried to pressure the BOJ not to hike policy rates further, we feel a further 25bps hike will arrive in the spring (most probably in April) given that headline and core inflation argue for some further normalization. JGB yields have also moved significantly higher in recent months, and the historic relationship between yield spreads and USD/JPY suggests USD/JPY should already be a lot lower (Figure 5). &nbsp;Indeed, the BOJ QT continues to become more aggressive, as they are scaling down bond buying alongside allowing redemptions to roll off. &nbsp;We see QT getting to 6% of GDP and causing a spike in 10yr JGB yields to 2.5% or above, which could be an event risk for the JPY bears. &nbsp;&nbsp;Figure 5: USD/JPY and 10 year yield spread<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c1109a3c7aa.JPG" style="width:100%;"></figure>Source: Datastream, CEHowever, the relationship between USD/JPY and yield spreads appears to have broken down for now, although history and theory suggests this will not last indefinitely. There has also been a strong historic relationship between equity risk premia and the JPY (Figure 6 show ERP and EUR/JPY for a change), which, though less theoretically sound, has held up better in recent months. This suggests that we will need to see a bigger turn lower in U.S. equities or, more precisely, a turn higher in equity risk premia for the JPY to turn. The Iran war has prompted a modest shakeout in U.S. equities, but we feel U.S. valuations are so stretched that they can prompt a deeper U.S. equity correction later in the year. Bigger picture, we would expect USD/JPY to move closer to long term fair value in the next couple of years. Purchasing Power Parity for USD/JPY is below 100, but as long as real yields in the U.S. are relatively high the USD can be expected to trade well above that. Even so, with JGB yields likely to rise in the coming years, we would expect to see USD/JPY close to 130 by the end of 2027. Very rapid JPY gains may be seen in the event of a sharp U.S. equity correction. &nbsp;For end 2026, we would still be inclined for this extreme JPY undervaluation to be reconsidered, but we now look for 148 rather than 140, as the Iran war and Takaichi success has depressed JPY sentiment. &nbsp;Also the new Japanese government have verbally protested recent JPY weakness, and the level of the JPY is so weak that intervention to support it would be seen as acceptable.Figure 6: &nbsp;US real equity risk premium and EUR/JPY<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c11258b28b2.JPG" style="width:100%;"></figure>Source: Datastream, CE, FREDGBP to edge lowerWe expected GBP to continue the gradual decline against the EUR seen through this year. Though the market has abandoned BOE rate cut expectations during the Iran war, as UK economic slack and the recent tightening in UK financial conditions will likely mean that the BOE does not actually hike rates (here). &nbsp;Indeed, as energy prices come down in H2 we would see a refocus on underlying softer UK inflation. &nbsp;The labor market remains the weakest in the DM, as poor business confidence and government multi-year fiscal consolidation are leading to job losses that will feed into further slowing of wage inflation. We expect the Bank of England to cut rates in H2 2026 and 2027 in contrast to current overdone tightening expectations. &nbsp;While we also see potential for the ECB to ease again this is only 25bps compared to 75bps from the BOE. Nominal and real yields spreads should move in the EUR favor. Politics is a swing factor for GBP in 2026 and 2027 ahead of a 2029 general election, with a high risk that PM Starmer or Chancellor Reeves could be replaced. This would likely lead to a softening of the fiscal rules rather than a major fiscal easing but could temporarily boost 10yr yields (here) but hurt GBP. &nbsp;Even so, GBP weakness is unlikely to be dramatic in 2026, with EUR gains likely to be capped at 0.90.&nbsp;Figure 7: EUR/GBP and 2 year yield spread<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c110cc73e9b.JPG" style="width:100%;"></figure>Source: Datastream, CE&nbsp;

Our baseline is for a 4-8 week Iran war, with WTI down to USD80-85 by June; USD65-70 end 2026 and USD60 by Q3 2027. This should see the USD return to 

DM FX Outlook: The Rest of 2026

Foreign Exchange

FX Forecast

Figure 1: 9mth Total Returns Versus the USD (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c28fab53a11.JPG" style="width:100%;"></figure>&nbsp;&nbsp;Source: Continuum EconomicsAsiaThe Yuan has remained strong in 2026, with little complaint yet from China&rsquo;s authorities. Part of this is a willingness to allow a modest Yuan appreciation in the face of the huge China trade surplus and pressure from U.S./Europe/IMF and others over an undervalued Yuan (falling export prices means that the Yuan has depreciated in real terms in the last few years, see Figure 1).&nbsp; Part of this willingness to allow appreciation is also designed to soften U.S. trade pressures and the risk of an aggressive section 301 action from the U.S.&nbsp; China wants the trade truce with the U.S. reconfirmed with the delayed President Xi and Trump summit in China.&nbsp; However, China is not keen on a formal trade deal that could incorporate numerical targets to reduce the bilateral trade surplus on a multi-year basis.&nbsp;Figure 2: Yuan Nominal and Real Effective Exchange Rate (Index)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c251318e7b9.png" style="width:100%;"></figure>Source: Datastream/Continuum EconomicsHow much China is willing to allow the Yuan to appreciate against the USD is not currently clear, as the Yuan real depreciation (Figure 2) could allow lots of room.&nbsp; Previously Yuan appreciation has occurred in a stepwise fashion.&nbsp; A 2.5-5% appreciation followed by smoothing FX intervention to allow the Yuan to consolidate followed by further appreciation.&nbsp; Some have also focused on the extra line recently added to President Xi Jinping's 2024 speech that the yuan should be widely used in global trade, investment, FX markets, and more importantly, have the status of a global reserve currency.&nbsp; Some argue that this could mean China authorities are happy to allow a larger and more persistent Yuan appreciation. We are less sure, as this is a long-term multi-year goal rather than for 2026, as capital flow restrictions remain.&nbsp; For the Yuan this all likely means that China is happy to allow Yuan appreciation to 6.80 in 2026, but not 6.40-6.50 that would undermine the competitive edge from the decline in the real Yuan over the last few years.&nbsp; Some further appreciation can be seen in 2027, given a multi-year USD decline against low inflation countries and we see USD/CNY at 6.75 by end 2027.&nbsp;&nbsp;The Iran War has caused divergent pressures elsewhere in Asia.&nbsp; The India Rupee (INR) has been hurt by India dependence on oil and gas through the Straits of Hormuz.&nbsp; On our baseline of 4-8 week war (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>), the INR should stabilise &ndash; especially as RBI FX intervention continues to smooth the INR.&nbsp; However, the pre-war goldilocks macro backdrop (controlled inflation and good growth) will take a number of quarters to return and a return of asset flows.&nbsp; India will probably accept stabilisation rather than trying to get a rebound and we forecast USD/INR at 93.50 for end 2026. Even so, the INR has fallen a lot on a real effective exchange rate (REER) basis and India authorities would fight any speculative attack for a bigger INR decline via FX intervention. An RBI rate hike is possible if the war last months and causes a bigger lift to CPI inflation, but not on a 4-8 week war given the RBI dovishness.&nbsp; The Indonesia Rupiah (IDR) has been more impacted by risk off attitude towards Asian assets than the macro impact, as well as concerns that government fiscal consolidation could be weakening.&nbsp; We see scope for IDR to stabilise and potentially bounce to 16800 by end 2026. &nbsp;In contrast, the Malaysian ringgit (MYR) will remain supported by the prospect of still elevated energy prices in 2026, alongside the ongoing AI semiconductor boom. These will likely be enough to limit the reversal of MYR strength and we see USDMYR at 3.95 on USD/MYR by end-2026. &nbsp;Though the MYR REER is at the 2016-26 range, it is still 13% off the post 2008 highs seen in 2013.LatAm: Rebound Limits?The Iran war risk off has prompted a partial correction against the USD, after BRL and MXN have seen strong starts to 2026 helped by carry trades. What are the prospects and how much further can this go into 2026?&nbsp;BRL interest rate differential versus the U.S. will decline, as the BCB has starts an easing cycle and we forecast around 250bps of easing in 2026.&nbsp; However, real yields still remain attractive and with Brazil inflation coming under control, the prospect remains for carry trades to return in H2 2026.&nbsp; Q1 has also seen the election be a tailwind, as Flavio Bolsonaro is tied with Lula in 2nd round polls and this could mean a more market friendly government after the October election.&nbsp; One question being asked is whether the BRL has now overshoot and is overvalued?&nbsp;&nbsp; On some USDBRL fair value estimate it is overvalued, but looking at the BRL REER versus 10yr average (Figure 3) it is still undervalued.&nbsp; Additionally, the pre GFC experience showed extended BRL rallies against the USD in a weak USD environment when wide interest rate differentials existed.&nbsp; We feel that BRL could still appreciate against the USD as long as yields differentials remain wide. Though the U.S. tariff rates on Brazil have now fallen after the switch to section 122 tariffs, the net effect is secondary to the rates, valuation and politics stories.Figure 3: BRL Real Effective Exchange Rate (Level)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c25148bb5f6.png" style="width:100%;"></figure>Source: Datastream and Continuum EconomicsEven so, pre-election fiscal easing is now an increased risk with close polls and Q2 and Q3 will likely see a BRL consolidation as the political race intensifies. Post-election USDBRL will end 2026 at 5.20 if Lula wins, but 5.00 if Flavio Bolsonaro wins.&nbsp;2027 will likely see more BCB cuts to 9.50%, but then lower short and long-term yields help reduce government debt servicing and we would also see some fiscal consolidation.&nbsp; This can keep the BRL underpinned and we forecast 5.10 for end 2027.&nbsp;The MXN has not been impacted by President Donald Trump desire to renegotiate USMCA in 2026, as desires have not yet been followed by threats.&nbsp; However, USTR Greer is clear that Trump wants separate addendums for Mexico and Canada for the USMCA, which suggests that bilateral threats could still increase volatility when negotiations intensify around July 2026.&nbsp; This may mean that MXN recovery is delayed and losses could be seen mid-year. It also worth noting that the MXN has now become overvalued versus 10 and 25yr average on an REER basis (Figure 4).&nbsp; This could bring USDMXN back to 18.00-18.25. &nbsp;Even so, with the Fed and Banxico likely to both cut by 50bps this year, interest rate differentials will still encourage carry trade to return and we see USDMXN at 17.50 by end 2026.&nbsp; MXN will also be supported by the view that U.S./Mexico will agree a renegotiated USMCA successfully by early 2027, which is rightly regarded as a long-term positive &ndash; the alternative risk of no renewal and USMCA ending in 2036 is low risk, as Trump eventually wants a deal after his likely theatrics.&nbsp;Figure 4: MXN Real Effective Exchange Rate (Level)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c25156664d9.png" style="width:100%;"></figure>Source: Datastream and Continuum EconomicsFor 2027, the bottom of U.S. policy rates should start to reduce the benefit of still favorable interest rate differentials for MXN. This can see the MXN slipping to 18.00 on USDMXN by end 2027, given the current MXN overvaluation.&nbsp; &nbsp;&nbsp;EMEAEMEA currencies continue to exhibit sharp divergence driven by inflation and interest rate differentials and idiosyncratic risks. When compared with December outlook, the recent conflict in Iran has introduced a new layer of volatility through energy channels and risk-off sentiment.On our baseline for the Iran war, moderate downward pressure will remain for TRY the rest of 2026 as inflation remains much higher than Turkiye&rsquo;s main trading partners, the current account deficit is large and foreign capital inflows are weaker-than-expected. Turkey also faces significant lagged risks due to the conflict in Iran, including surging transportation costs, delivery delays, and diminished export competitiveness across multiple sectors. Higher energy prices and logistical disruptions push fertilizer costs up further, increasing production costs for key crops such as wheat, corn and sunflower and potentially feeding into food inflation. These will put downward pressure on the TRY, and we think TRY will still be falling on a spot basis. Our prediction for the USD/TRY rate now stands at 49 by the end of 2026, and 54 for end 2027. (Note: Stubborn inflation could stay above expectations due to sticky food and services prices coupled with secondary impacts of surges in energy prices which would mean more TRY depreciation than our central scenario, likely pushing the rate over 50 for end-2026). Domestic political developments should also be watched, as we look for an early presidential election in September 2027.Turning to South Africa, ZAR had benefitted from previous gold/metals rally, increasing business confidence, bettering investment environment, no power cuts and removal from the global grey list so far in 2026, before the Iran war prompted profit-taking. However, concerns remain regarding narrowing yield spreads against the U.S. and potential trade tariff rhetoric from the U.S. administration, both of which are compounded by the adverse impacts of the war in Iran. We expect rising production and transportation costs, surges in oil prices, declining export competitiveness will put downward pressure on the ZAR in Q2/Q3. SARB will halt its easing cycle, while we expect a cautious and data-dependent SARB will likely try to bring inflation down to new 3% anchor (we forecast inflation is set to move to 4% in Q2/Q3). Under current circumstances, our end year USD/ZAR rate prediction stand at 17.5 for 2026, and 17.7 for 2027.&nbsp;&nbsp;Although, not our primary in-house scenario, we think a 2-6 month conflict (<a target="_blank" href="https://continuumeconomics.com/a/e057f209/iran-war-scenarios-updated">here</a>) in Iran would likely trigger stagflationary shocks for EM countries as surging energy costs would put pressure on the current account balances and also weakening capital flow, as well as boosting inflation more than our baseline forecasts. This could particularly put extra downward pressure on the ZAR and TRY. With oil prices potentially surging toward USD 120&ndash;180, EM central banks might be forced to cancel planned interest rate cuts or, in some cases, implement modest rate hikes to counteract second-round inflationary effects. EM central banks will likely want to avoid rate hikes if the war is 4-8 weeks, which remains our main scenario.Elsewhere, we envisage RUB would remain volatile the rest of 2026. Despite moderate easing, inflation differentials against the U.S. remain wide, and the Central Bank of Russia (CBR) struggles with a sticky inflationary environment that is not cooling as fast as CBR expects since foreign capital inflows remaining weak until sanctions are lifted and global investor confidence in Russia rebuilds. We assess macroeconomic instability will remain substantial unless the Ukraine war comes to an end. (Note: Our baseline scenario in Ukraine is the war dragging on throughout 2026 (70%) and the alternative is a Russia friendly peace deal (30%)). RUB will still be falling on a spot basis in 2026, and our end-year USD/RUB rate predictions are at 88 and 91 for 2026 and 2027, respectively. We think high domestic gas and oil production will curtail domestic energy prices in contrast to global energy prices while higher global oil prices in Q2/Q3 and temporary sanctions relief due to the Iran conflict could boost Russia crude exports and help relieve fiscal pressures. (Note: Higher energy revenues may facilitate expanded military spending, potentially triggering demand-pull inflation. Conversely, they could moderately decelerate inflation via the FX channel, although the impact of sanctions would likely limit this effect. We expect the net result to be a secondary rather than a dominant factor on RUB).&nbsp;Figure 5: USD/ZAR Rate and 10yr South Africa-U.S. Government Bond Yield (%)<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c250a820e17.JPG" style="width:100%;"></figure>Source: DataStream/Continuum Economics

·       EM currencies have seen a correction against the USD since the risk off prompted by the Iran war, but our baseline remains for a 4-8 week war

EM FX Outlook: Weathering the Storm

See below or download the PDF to see our key technical analysis views.<figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92115226.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92172dc2.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9217b9fa.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92172215.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9215a7aa.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92161fef.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92165c2c.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9215a99e.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9216bf5f.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b921760cf.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9216ccd3.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9211e6b1.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9216b462.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b921556c2.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92116ce3.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9217738f.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92178654.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9212f167.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92163a3c.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92163892.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b9217431d.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92174bfd.JPG" style="width:100%;"></figure><figure class="image"><img src="https://assets.continuumeconomics.com/storage/uploads/69c2b92171efc.JPG" style="width:100%;"></figure>&nbsp;&nbsp;

Our latest quarterly technical analysis views on Bonds, Equities, Commodities and FX is now available.  

Charting Our Views: Technical Analysis for Q2 2026

Technical Analysis

ChartBook

IRAN, ISLAMIC REPUBLIC OF

How long will the war with Iran last and what will happen to energy prices in the coming quarters?&nbsp; &nbsp;Figure 1: Iran War Scenarios and Oil Prices &nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;<figure class="table"><table><tbody><tr><td style="background-color:#E7E6E6; border:1.0pt solid white">&nbsp;</td><td style="background-color:#4472C4">Baseline&mdash;65%</td><td style="background-color:#A5A5A5">Upside&mdash;30%</td></tr><tr><td style="background-color:#E7E6E6">&nbsp;</td><td style="background-color:#8EAADB">4-8 week war</td><td style="background-color:#C9C9C9">2-6 month war</td></tr><tr><td style="background-color:#F7CAAC">Summary</td><td style="background-color:#D9E2F3">U.S. declares victory due to high gasoline prices and Trump loathing of long wars.&nbsp; A formal ceasefire is unlikely, as Trump wants the PR of victory.&nbsp; However, some informal understanding on the Straits of Hormuz could allow most shipping to resume.&nbsp; Israel would likely cease military action against Iran at the same time as the U.S.&nbsp;Shipping could recover and energy flows/strategic oil reserve release help to reduce the oil risk premium by mid-year.&nbsp; We would see WTI at USD75-80 by June and USD65-70 by end December.&nbsp;A limited formal ceasefire would help restore energy flows quickly and help easy oil prices.&nbsp;</td><td style="background-color:#EDEDED">Iran fights on against U.S./Israel targets in the region, as U.S. reluctant to make concessions to Iran which wants to force agreement on no future wars.&nbsp; Iran could use drones for many months to cause mid-level problems around the region and effectively close the Straits of Hormuz.&nbsp; Could see escalation with U.S. invasion of Kharg island and Iran attacking more energy facilities in the region.&nbsp;&nbsp;Strategic oil reserve release work for a 4-8 week war, but not a 2-6 month war and effective closure of the Straits of Hormuz. Oil prices would thus have to rise to cause some demand destruction around the world.&nbsp; We would see WTI at USD120-180 by April/May depending on the length of the war and USD80-110 by end December, as imbalance would spill over the whole of 2026. &nbsp;&nbsp;</td></tr></tbody></table></figure>&nbsp;&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Source: Continuum Economics.&nbsp; Other scenarios are less than 5% e.g. &nbsp;Collapse of regime/Civil War and move towards free election or IRGC overthrowing clergy.&nbsp;We are fine tuning our Iran war scenarios (Figure 1).&nbsp; The U.S. on balance is heavily biased towards a 4-8 week war, both as high gasoline/diesel prices risk the GOP losing the Senate as well as the House in November mid-term elections and as Trump strong bias is against long wars. Trump threat March 21 to bomb Iran&rsquo;s power plants and then subsequent decision to postpone for at least 5 days is consistent with this 4-8 week war view.&nbsp; The one issue is that Trump does not like the image of him losing and so any end to fighting will be declared a victory for PR spin. &nbsp;Israel would likely stop attacks on Iran with the U.S. end of military strikes.&nbsp; Israel could have an election as early as May and Netanyahu claims Iran nuclear capabilities is crippled. &nbsp;However, Israel has signalled it would likely continue the war with Hezbollah.&nbsp; Iran is the key swing factor between a 4-8 week war and 2-6 month war.&nbsp; Iran is asking for U.S. and Israel commitment against future attacks or they will continue the asymmetric war against energy and effective closure of the Straits of Hormuz.&nbsp; However, Iran has suffered severe damage to conventional military offense and defence and is vulnerable to its shipping/exports being stopped e.g. Blockade or invasion of Kharg island.&nbsp; On balance, Iran will likely accept an end to hostilities rather than fighting on.&nbsp; We thus feel that a 4-8 week war is the highest probability, but this is unlikely to see a formal ceasefire with concessions (see below). The scale of energy infrastructure damage is also a further consideration for future energy prices and economic effects. &nbsp;We highlight below the two main scenarios that could occur, with some broad estimate of probability &ndash; with the understanding that these will likely change based on decisions in Iran/U.S. and Israel.&nbsp; &nbsp;&nbsp;&nbsp;&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; 4-8 week war (65%). &nbsp;Military and state infrastructure damage in Iran sees Iran authorities stopping the war alongside the U.S. This could involve no formal ceasefire, as Trump PR instincts mean he wants to claim victory without concessions. This could occur in the next 1-2 weeks or Iran could drag it out until mid-April to try to get concessions from Trump. &nbsp;If no ceasefire agreement is reached then the U.S. will likely try to reach an informal understanding with Iran that the Straits of Hormuz should open to most shipping, as an act of goodwill on all sides. This would still be a fragile post war environment, with a risk that it could see a restart to the war.&nbsp; This could keep demand higher than normal and slow the decline in energy prices.&nbsp; However, it is feasible that the Trump administration could give a commitment not to attack over a specified period that could be enough for Iran to agree a formal ceasefire and allow the Straits of Hormuz to fully reopen &ndash; Israel would likely not agree to not attack in the future, but Iran would hope that U.S./GCC pressure would curtail Israel.&nbsp; If a ceasefire is agreed then the Straits of Hormuz shipping could recover more quickly and energy flows help to reduce the oil risk premium by mid-year.&nbsp; On balance, we go for a no formal ceasefire agreement and we would see WTI at USD75-80 by end June and USD65-70 by end December.&middot;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; 2-6 month War (30%).&nbsp; Iran fights on against U.S./Israel targets in the region, as U.S. reluctant to make concessions to Iran and Iran wants to force agreement on no future wars.&nbsp; Iran could use drones for many months to cause mid-level problems around the region and effectively close the Straits of Hormuz.&nbsp; The U.S. proposal of a naval escort without a ceasefire would be dangerous, as the effective channel is 4kms for oil supertankers and closer to the Iranian shoreline!&nbsp; &nbsp;War lasts months rather than weeks, which then leads WTI oil prices to USD120-180 (wide range reflects uncertain over length of 2nd scenario and further energy infrastructure damage) as oil exports through the straits of Hormuz remain heavily restricted and strategic oil reserve release is insufficient. Though IEA countries have released 400mln, the estimated loss excluding redirected via pipeline is around 11-16mln of crude oil and products per day.&nbsp; China is starting to release some of its huge commercial stockpile, but is reluctant to rundown too far. Oil reserve release works for a 4-8 week war, but not a 2-6 month effective closure of the Straits of Hormuz. Oil prices would thus have to rise to cause some demand destruction around the world. &nbsp;This scenario could also involve some more lasting damage to oil and gas production facilities in the region. Could see escalation with U.S. invasion of Kharg island and Iran attacking more energy facilities in the region.&nbsp; Eventual end to the war, but with very fragile situation meaning oil prices come down but risk premia would be higher than the 4-8 week war scenario above.&nbsp; We would see WTI at USD120-180 by April/May and USD80-110 by end December, as excess of demand over supply would spill over the whole of 2026. &nbsp;Figure 2: Iran War Scenarios and WTI Oil Price Projections&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<img src="https://assets.continuumeconomics.com/storage/uploads/69c155b50268d.png" style="width:100%;">Source: Continuum Economics.&nbsp;Natural gas prices outside the U.S. will be elevated for longer, with 17% of Qatar LNG export facility damaged for 3-5 years.&nbsp; Under a 4-8 week war, some gas flows in Q2 would resume and we forecast European TTF at Eur55 for end Q2 and Eur48 for end Q4.&nbsp; This has an important impact on Asia and Europe economies. &nbsp;&nbsp;

·       Our central scenario remains a 4-8 week war in Iran. Trump's loathing of long wars and high gasoline prices will likely prompts the U.S. to d

Iran War Scenarios Updated

March Outlook: Iran War and AI Challenges

Continue to read the article for free