The US economy remains solid and is growing above the long-term trend, supported by expansive fiscal policy and investments in AI. Given the country’s energy self-sufficiency, the impact of rising oil prices on US growth should be less severe compared to other developed economies. However, the impact on inflation is more pronounced. The labor market is cooling but remains resilient. This leaves the Federal Reserve little room for easing. We expect the Fed to keep interest rates unchanged this year. Now that the legal proceedings against Fed Chair Powell have been dismissed, we anticipate Congress will proceed with confirming nominee Kevin Warsh as the next Fed Chair.
Due to its dependence on energy imports and the larger weight of energy-intensive sectors, the euro area remains more vulnerable to the energy shock than the US. Germany’s broad economic stimulus package will continue to support demand, but higher oil and gas prices pose a significant risk to the recovery and are already weighing on sentiment indicators. For this year, we forecast euro area growth to slow to 0.8% and inflation to rise to 2.8%. We expect the ECB to raise interest rates in June and September to ensure inflation expectations remain well anchored. In Switzerland, a rate hike by the SNB is unlikely, as the franc remains strong, energy has a smaller weight in the consumer price index, and inflation is rising from a low base. The UK economy appears more fragile, with weak growth, high energy dependence, and limited political support. Therefore, we expect the Bank of England to raise interest rates only once in 2026.
Asia continues to be disproportionately affected by the closure of the Strait of Hormuz, as many of its economies heavily depend on energy imports from the Middle East. Japan continues to face a difficult combination of expansive fiscal policy, rising inflation, and higher import costs. Nevertheless, we expect the Bank of Japan to raise its key interest rate twice this year. China is in a better position than most oil importers. Although it is the world’s largest crude importer, this accounts for only about one-fifth of the country’s total energy consumption. Moreover, retail fuel price regulation limits the impact of consumer price inflation. Exports, particularly of green technology-related goods, remain strong, while new investment projects should support domestic demand. We continue to forecast Chinese economic growth of 4.5% in 2026, accompanied by consumer price inflation of 1.4%.
BONDS – DURATION IS BECOMING MORE ATTRACTIVE
The rise in energy prices caused by the war has pushed up inflation expectations and market-expected reference rates, especially in Europe. However, these developments may be somewhat premature. Rising reference rates and energy costs are likely to weigh increasingly on growth over the coming months, which should shift bond market focus from inflation to growth. As a result, duration prospects should improve. Yield curves have flattened following strong repricing and are unlikely to change much until central banks resume rate cuts in 2027. We continue to favor medium-term maturities from five to seven years. Credit spreads have widened only moderately and remain close to historic lows. Since risk premiums are low, we maintain a neutral stance on corporate bonds. Based on a solid macroeconomic environment, however, we expect high-yield bonds to outperform in the second half of the year. We hold an equally positive view on emerging market bonds.
STOCKS – STRONG CORPORATE EARNINGS DRIVE STOCK PRICES HIGHER
Global equity markets reached new all-time highs in early May: the US and emerging markets have recently outperformed Europe. First-quarter 2026 results appeared particularly strong in the US: S&P 500 company earnings increased by about 30% year-on-year. Market valuations have risen slightly again but remain within a reasonable range. We anticipate a shift among different market segments. In particular, we see cyclical stocks and small caps, which had recently performed well, losing momentum, while growth stocks are coming back into focus.
We continue to see significant potential in the AI sector, which has played a key role in strong earnings growth. The expansion of necessary infrastructure requires substantial investments. Demand for semiconductors and data centers continues to grow, driven by an increasing number of commercial users and rising revenues from artificial intelligence services.
From a regional perspective, we continue to favor emerging market equities, as earnings are supported by the technology cycle in Taiwan and Korea and should benefit from a weaker dollar over the course of the year. At the sector level, we favor technology, communication services, utilities, and healthcare. We are less optimistic about consumer staples, whose valuations appear expensive to us. We also recommend caution regarding energy stocks, as oil prices are expected to normalize toward the end of the year.
