In its Annual Economic Report, the Bank for International Settlements has highlighted four pressure points for the global economy.
The Bank advised that financial markets have remained buoyant, despite recent challenges associated with conflict in the Middle East, reflecting expectations that the disruptions will be short-lived and that the AI boom will continue.
In its advice to public policy makers, the bank is sounding a warning that four pressure points may dent these expectations:
- Inflation has made a comeback. Although the recent conflict in the Middle East seems to have abated, the economic effects of the Hormuz disruption may linger as the full restoration of physical energy supply takes time and the initial price increases propagate through supply chains. The closure of the Strait of Hormuz was the latest in a sequence of supply shocks. It triggered a crisis in the supply of energy and other raw materials, driving a surge in prices across the globe that may linger. A key question is whether initial price increases will become ingrained.
- The optimism surrounding AI may not last, despite its promise of future productivity gains. The current surge in capital expenditure could prove unsustainable if supply bottlenecks restrain production. Intense competition for market leadership may fuel overinvestment further, as seen in previous innovation waves, increasing the risk of a sharp reversal if AI payoffs disappoint.
- Financial vulnerabilities persist. Present easy financial conditions could tighten and become a potent amplifier in adverse scenarios where interest rates rise, and AI payoffs disappoint. Compressed risk premia and stretched valuations highlight the scope for unwinding. Increasingly opaque financing of AI activities, high leverage in core markets and the growing footprint of private credit further undermine the resilience of financial markets. The current tension between exuberant risk appetite and elevated macroeconomic risks could unwind abruptly.
- Fiscal pressures are mounting. With already high debt levels, governments face rising demands for spending amid energy shocks and geopolitical tensions.
While the report is principally directed at public policy makers, it sounds a warning that geopolitical headwinds and rising fiscal and financial fragilities remain.
I expect that there will be uncertainty ahead, and it may be for an extended period of time as we head towards the US mid-term elections in November and the uncertainty changes to the US Congress may create.
As always, and particularly during periods of heightened uncertainty, we encourage investors to focus on their longer-term goals, remain patient during short-term market fluctuations, and maintain a portfolio aligned with their timeframe, objectives and risk tolerance.
Please contact Kapiti Financial Advice if you would like to discuss whether your portfolio is appropriate for your timeframe, objectives and risk tolerance.