Outlook Overview: Navigation Into 2027
· The hot phase of the Iran war is over, but the intermittent conflict between the U.S. and Iran is stopping shipping via the Straits of Hormuz from fully recovering and keeping energy prices elevated. Some DM and EM central banks are guarding against 2nd round effects with modest tightening, but the situation remains different from 2022 (more labour market slack, less supply constraints, less boost from fiscal policy, policy rates that were neutral or mildly restrictive in spring 2026). We attach a 60% probability to a 2nd ceasefire being agreed on economic grounds (here), which will likely ease energy prices into 2027. In this environment, we feel that central bank tightening will slow and stop into 2027, though a further 25bps ECB and Fed hike (here) are likely in Q4. Indeed, where AI is not producing a material boost to the economy, we see disinflation pressures prompting central banks to undertake small to modest easing in H2 2027 (eg ECB and BOE). Indeed, we still see the Fed cutting in H2 2027, as the K shaped economy sees most consumers slowing consumption and forcing the Fed to ease the scale of restriction. Meanwhile, provided that AI labs revenue continues to grow strongly (Anthropic and Open AI), then data center building/cloud compute spending and semiconductor manufacturing should continue to boost the U.S. and parts of Asia.
· EM central banks will diverge and a few may still follow the SARB/BI rate hike to guard against 2nd round effects eg RBI. Brazil will likely pause in Q1 2027 awaiting fiscal policy details but will resume consistent easing in 2027, while Mexico will remain on hold as they do not want to upset the economy. Most EMs are also helped by more labor market slack than 2022. Meanwhile, China 2026 inflation rise will fade in 2027, as the excess of production over domestic demand produces ongoing disinflation. However, PBOC will remain reluctant to ease, due to concerns that policy rate cuts could squeeze banks margins and hurt lending growth. Fiscal policy stimulation in 2027 will also be similar to 2026, with enough to support the economy but not to boost the GDP growth rate.
· Outside of Iran, the odds of a China attack on Taiwan remain at 5-10% for 2026-27, but we have raised the odds of a China coastguard quarantine of Taiwan to 20% in 2027 (here). This would be temporary and fall short of an act of war, but could significantly impact financial market sentiment if it occurred. Meanwhile, we feel that a Russia-friendly peace deal in Ukraine could eventually arrive by H2 2027 due to exhaustion. Finally, a multi-day war between India and Pakistan over Kashmir claims is likely in the next 3-12 months, but not a long war.
· For financial markets, rising long-end government bond yields reflect higher real yields rather than inflation expectations and we do not see this getting out of hand outside of Japan (BOJ QT is 6% of GDP in 2026 and could spike JGB yields still further before prompting a U turn). Short end government bond yields should peak and move modestly lower, as expectations swing towards 2027 easing. Equity investors have taken note of higher U.S. Treasury yields, but the influence of the AI boom and corporate earnings is greater. Though risks exist of a 5-10% correction, U.S. equities can be driven further by the tech story we see the S&P500 reaching 8200 by end-2027. Other DM equity markets and China will find it difficult to outperform the U.S. in 2027, as markets are no longer cheap. Brazil is our favorite over the next 15 months, as policy rate cuts helps boost the fwd P/E ratio and drive the market higher. In FX, the USD can see a slow decline resuming versus most DM currencies into 2027, though H2 2026 will likely be choppy.
· Risks to our views: Our alternative Straits of Hormuz scenario at 40% is that shipping remains disrupted in the next 12 months, which keeps inflation higher for longer. This can mean some further tightening from select DM and EM central banks.