Macro Matters: Is It Time to Price in Geopolitical Risk?

Updates to our economic outlook:

Global growth expectations continue to cool as the effects of a prolonged closure of the Strait of Hormuz trickle through the global economy. A sequence of supply shocks is increasing uncertainty and weighing on sentiment. High-frequency indicators, like purchasing manager’s indexes or the Atlanta Fed’s gross domestic product (GDP) tracker, point to a further slowing of growth. While U.S. growth is also slowing, it is relatively cushioned by continued strong artificial intelligence (AI) spending and loose fiscal policy. In contrast, parts of Asia and Europe are much more dependent on Middle Eastern oil and gas and lack comparable domestic growth tailwinds, worsening the growth/inflation trade-off in those regions. Under normal circumstances, this type of environment would naturally lead to higher fiscal spending if not for already-stretched government balance sheets. We have seen more fiscal spending on the margin through energy subsidies, and additional spending is likely should the situation deteriorate further.

Inflation is rising globally, though most of it remains concentrated in headline measures. Core inflation has stayed well behaved so far, and it would require further tightening in commodity markets for companies to pass higher input costs through more broadly into core prices. In the U.S., core prices remain supported by a weaker housing market, and the tariff impact from last year is fading. Internationally, however, inflation is experiencing stronger upward pressure despite weaker growth.

Rising inflation and the lack of progress in Iran negotiations have left central banks and governments in a difficult spot. Central banks are on hold for now, though we can’t rule out a short-term overreaction—particularly in Europe, where central banks tend to focus more on prices. The Fed remains on hold, focused on balancing the dual mandate of inflation and growth. The Fed is likely to be cautious about any further upward pressure signaled by higher-frequency survey indicators. Inflation has stayed above the 2% target for five years, and it currently looks unrealistic to expect prices to return to that target level within the next year.

Our base case remains a data dependent Fed on hold, but Europe faces a higher risk of policy error, where rate hikes in a weak growth environment would likely tip the economy into recession.

Prospective changes to asset allocation:

• Equities
  We currently favor U.S. equities and Asian markets over European equities. The information technology sector continues to deliver strong earnings growth, while European equities are impacted by slowing global growth, rising input costs, and higher interest rates. The U.S.’s position as a net exporter of energy, combined with a stronger USD, should provide the economy greater insulation from higher energy prices. We believe developed ex-U.S. and emerging market (EM) equities remain cheaper and attractively valued over the long term, but weaker currencies, more hawkish central banks, and greater reliance on energy imports are likely to cause higher market volatility. Short-term sentiment shifts will likely lead to plenty of market noise.
• Fixed income
  We remain neutral on U.S. duration overall, with a preference for the intermediate part of the curve while underweighting the long end. Yields in developed ex-U.S. markets remain elevated and volatile, but we see increasingly attractive longer-term entry levels given compelling all-in yields.
• Commodities and foreign exchange
  We continue to favor commodities through a broad-based allocation. Energy commodities remain supported by the lasting damage to energy infrastructure in the Middle East and the ongoing geopolitical deadlock. Beyond energy, we favor agricultural commodities and have become more constructive on industrial commodities supported by the AI boom and continued infrastructure build-out. From a currency perspective, we remain positive on select countries that benefit from the commodity boom, reduced geopolitical exposure, and stronger domestic economies, such as the Brazilian real and the Mexican peso.

Multi-asset allocation views:

These multi-asset views reflect tilts to our strategic asset allocation models and are based on a 6- to 12-month time horizon, driven by both quantitative and fundamental research.
+ (Overweight on overall asset class)    
= (Neutral on overall asset class)  
– (Underweight on overall asset class)

Forward investment implications:

The Atlanta Fed GDP tracker (formally called GDPNow) is a real-time estimate of U.S. economic growth produced by the Federal Reserve Bank of Atlanta. It is a model-based, continuously updated forecast of real U.S. GDP growth for the current quarter, expressed at an annualized rate.

Curve steepener refers to a change in the yield curve where the difference between long-term interest rates and short-term interest rates increases, making the yield curve steeper.

Duration is a measurement of the sensitivity of a bond’s price to changes in Treasury yields. A fund’s duration is the weighted average of duration of the bonds in the portfolio. Duration should be interpreted as the approximate change in a bond’s (or fund’s) price for a 100-basis-point change in Treasury yields. Duration is based on historical performance and does not represent future results.

Hedging a bond means using a separate investment to offset the potential risks of the bond.

Purchasing Manager’s Index (PMI) is an economic indicator that measures the health of a country’s manufacturing or services sector.

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Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

This material is provided for informational purposes only and is intended for retail public distribution in the United States. Use outside the United States is for professional/qualified investors only.

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