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The global economic recovery is currently on a fragile path, with a multitude of intersecting risks threatening to disrupt its progress. According to Altaf Kassam, responsible for investment strategies in the EMEA economic region at State Street Global Advisors, these risks include renewed inflationary pressures, political and geopolitical uncertainties, and Covid-19-related disruptions.
From a regional equities perspective, the United States is preferred, but Europe and emerging markets are also on a robust growth path. The gap between the U.S. and Europe is expected to narrow by the end of the year, indicating a shift towards a more international orientation in the U.S. market leadership.
In the current pandemic-focused climate, setbacks in global progress against Covid-19 remain a significant risk. Although major disruptions have receded, the pandemic's economic impact lingers, particularly in manufacturing and supply chains. Any resurgence or new variant could trigger renewed volatility in financial and commodity markets.
Renewed inflationary pressures threaten to disrupt monetary policy adjustments, potentially affecting fiscal sustainability and financial stability. While some disinflation is occurring, inflation risks remain balanced, meaning inflation could either rise or fall unexpectedly, impacting markets. Inflation uncertainty complicates policymaking, which must carefully navigate the trade-offs between growth and inflation.
Considerable political uncertainty, especially notable in regions like Europe, dampens economic growth expectations by undermining consumer confidence and business sentiment. This uncertainty includes policy shifts and trade conflicts, such as tariff hikes from the United States, which slow down export sectors and overall global trade flows.
Heightened geopolitical tensions—evidenced by rising military spending in Europe and trade policy uncertainties—are weighing heavily on economic activity. These tensions create volatility in financial markets, exacerbate supply chain issues, and disrupt trade. Such shocks limit growth prospects and add unpredictability to recovery trajectories.
To counter these risks, investors are recommended to hold low-volatility equities, use options overlays, and employ multi-asset strategies with liquid assets. State Street Funds maintain a diversified position and have recently increased their overweight in Europe, reflecting the improvement in their quantitative framework for the region.
In the Pacific region, sentiment towards equities is turning, with a deterioration in sentiment values and unwanted momentum due to a relatively successful pandemic management waning. Emerging markets are benefiting from cyclical tailwinds, including the recovery of oil prices, relatively low inflation, and strong PMIs for the manufacturing sector. Local currency bonds in emerging markets offer upside potential through currency appreciation, while emerging market hard currency bonds have room for a narrowing of spreads.
Chinese equities are trading below their long-term average due to a decrease in correlation with other global markets, increased state interventions and regulations in the technology sector and e-commerce, and recent credit management issues. The fragile state of the market after more than a decade of accommodative monetary policy could lead to overreactions to any steps towards tightening by the Federal Reserve in the United States.
Combined with robust monetary and fiscal support, the economic recovery has been accelerated. However, the market is currently on a narrow edge between optimism and complacency, making it crucial for policymakers to balance these risks and rebuild economic buffers to sustain recovery momentum.
[1] Inflation Pressure [2] Potential Covid-19 Setbacks [3] Political Uncertainty [4] Geopolitical Conflicts [5] Divergent Growth Paths and Persistent Trade Policy Uncertainty
- Increased inflation risks could disrupt monetary policy adjustments, affecting the stability of both the finance sector and businesses as investors navigate the trade-offs between growth and inflation.
- The unpredictable course of the Covid-19 pandemic, with potential setbacks and new variants, could trigger renewed volatility in financial and commodity markets, weighing heavily on global economic recovery. This is especially true if it impacts manufacturing and supply chains, particularly in regions with ongoing uncertainty or weak economic buffering.
