The US economy continues to demonstrate resilience, with economic data remaining buoyant, despite energy market headwinds and rising interest rates. The credit cycle continues to accelerate, with momentum broadening beyond private credit. In the near term, fiscal spending has supported consumers while artificial intelligence (AI) capex is supporting a broad investment cycle. Inflation momentum has turned negative; however, near-term volatility in energy prices poses renewed headwinds to disinflation. While growth headwinds have risen with higher interest rates and the Fed’s return to tightening, the strength of the underlying growth impulse is expected to continue supporting US risk assets in the near term. However, downside risks are rising, with valuations increasingly elevated across all areas of the equity market and the AI capex cycle potentially approaching its peak, with limited policy support expected. The lagged impact of tighter financial conditions over recent months presents additional headwinds as we move into 2027.

ECB walks inflation tightrope

In Europe, economic momentum has rebounded strongly. The sustainability of this recovery will depend on the degree to which tighter policy and financial conditions and further energy price volatility weigh on consumers and businesses. While an improving credit cycle and expanding fiscal budgets in Germany and across Europe continue to pose upside risks, headwinds from higher interest rates, rising energy prices and uncertainty over the timing of fiscal support appear to be offsetting these in the near term. The European Central Bank has hiked rates to offset rising inflationary pressures and is likely to remain proactive, with a high sensitivity to inflation surprises. This increases the probability of further hikes, and, in turn, of a policy mistake. Political uncertainty in France has risen, adding further headwinds to growth and increasing stability concerns over European markets.

China balances stimulus and structural reform

In China, weak domestic activity over the summer has driven authorities to renew easing efforts and support economic stabilisation to ensure they meet their growth target. Overall, Chinese authorities continue to prioritise domestic consumption as a driver of growth. The “special action plan” outlines a broad set of measures to shift the economy away from its recent growth drivers, high value-add industry and exports, towards domestic consumption. Constraints remain on how far they can ease and support growth. Recent data shows some signs of a recovery from a weak base, with consumer confidence improving and a potential near-term bottoming in the property market. However, the overall credit impulse suggests households are deleveraging, an ongoing headwind to any growth recovery.

Positioning through a more challenging backdrop

Given our central investment roadmap, as discussed above, we continue to believe that risk assets will remain supported by a broad and robust growth backdrop in the near term. However, we acknowledge that downside risks are rising as central banks tighten policy and demand headwinds persist. Given elevated risks and stretched investor positioning across key areas of the equity market, we have been moderating our risk asset exposure at the margin and diversifying towards more defensive areas such as healthcare, and towards areas with broader performance drivers that have lagged more recently, such as the S&P 500 Equal Weight Index. In fixed income, valuations in defensive government bonds have reset notably, reflecting a reassessment of long-term real growth expectations. As a result, the longer end of yield curves and inflation-linked bonds are at levels that offer attractive diversifying qualities, in our view.

Defensive bonds

Bond markets have repriced on inflation risks from the Middle East conflict and the rate-insensitive AI capex cycle. Developed market central banks have resumed hiking and are expected to deliver several more hikes to offset broader inflationary pressure. Whether they follow through on current pricing will depend on how core inflation, inflation expectations and wages react to the energy shock. Inflation risks have risen, with underlying price pressures building and a new demand cycle possibly emerging. However, pricing looks extreme at current levels, which suggests bond markets offer some value. We prefer exposure where policy is already restrictive and likely to offset upward shocks, such as the UK and Australia. In the US, real yields have reset, particularly at the longer end of the curve, and offer attractive medium-term value.

Positive: UK, Australia long end, US TIPs, Norwegian steepeners

Growth bonds & credit spreads

Developed market credit spreads widened in the final weeks of September, giving back part of the month’s gains as the interest rate sell-off in developed market bonds gathered pace. High-yield bonds saw the largest spread widening, compounded by expanding supply. This recent volatility has improved valuations in areas of the credit market; however, on a longer-term basis they remain demanding. Underlying corporate fundamentals remain robust, but issuance dynamics are expected to remain a headwind over the coming months. Given the limited upside, we do not believe current valuations compensate investors for taking credit risk and prefer to express growth risk through equity.

Overall, we remain selective in our approach to emerging market fixed income. As in developed markets, emerging markets continue to face a volatile inflation backdrop with energy prices driven by the conflict in the Middle East, while El Niño adds further risks to food prices into 2027. How far these pressures affect the positive progress on inflation across most emerging markets will determine the extent to which bond yields can return to previous levels. We continue to focus exposure on areas where risk premia remain attractive and are supported by fundamentals, such as Brazil, Colombia and South Africa.

Positive: South Africa, Colombia and Brazil local currency

FX

The medium-term outlook for the US dollar is for weakness to persist, driven by dedollarisation flows. In the near term, US economic strength and the Federal Reserve’s hawkish shift should provide an offset, while European economies face growing stagflation headwinds from the energy shock and higher interest rates. In a multi-asset portfolio, the dollar remains an attractive hedge against stagflation risks. The Japanese yen is increasingly benefitting from policy support, as authorities try to reverse the depreciation of recent years and support portfolio flows. Japan’s economy is strengthening and inflationary pressures are broadening, so appreciation pressure on the yen looks set to grow. We have been building positions in the yen against the Swiss franc.

Positive: Japanese yen, US dollar, Brazilian real
Negative: Euro, Swiss franc

Equity

US equities continue to benefit from robust earnings and the structural growth of the AI capex cycle. Headwinds are growing as bond yields and discount rates rise, but strong earnings growth, particularly in AI-linked areas, has so far kept index-level valuations reasonable.

Sectors within regions have diverged widely. Cyclical areas, the most affected by higher bond yields, have seen valuations return to more attractive levels and as a result we have been leaning into areas such as industrials. Healthcare is attractive on valuation and more resilient to stagflationary outcomes.

Positive: S&P 500 Equal Weight, US healthcare, MSCI EM, Industrials

Commodities

We see compelling opportunities in natural resources. They are underpinned by structural demand (electrification), supply constraints and attractive valuations (high free cash flow yields and shareholder distributions). Widening fiscal deficits provide a further tailwind, given the sector’s role as an inflation hedge. Within energy, the conflict in Iran and the wider Middle East has disrupted supply and driven extreme oil price volatility that we believe energy equities are not fully pricing in, creating upside for active stock-pickers. Structurally, we see the oil market turning more constructive beyond the US midterm elections as shale growth fades, OPEC spare capacity normalises and EV adoption disappoints.

Gold has retreated from its highs but is forming a new base around US$4,000/oz,¹ supported by central bank and Asian buying as countries diversify away from the dollar. Fed Chair Kevin Warsh’s hawkish stance is a near-term headwind, but fiscal constraints on the Fed and slowing growth skew risks to the upside. With gold miners’ EBITDA margins still exceptional (averaging roughly 50% to 70%),² we expect robust equity returns, stronger still if gold moves higher. In base metals, aluminium faces a deficit until at least mid-2027, following Middle East supply disruptions, leaving prices skewed to the upside. Copper risks oversupply but should be supported by strategic stockpiling, though copper equities look fully valued. Agricultural markets are tightening as Middle Eastern nitrogen fertiliser exports are disrupted and El Niño-driven dryness threatens 2027 crops, although elevated grain and oilseed inventories (up 21% since 2015 as at 30 September) should partly cushion price pressures.

¹ The State Street Investment Management Monthly Gold Monitor.
² https://www.pwc.com/gx/en/industries/energy-utilities-resources/publications/mine.html