Macro Views: AI tailwinds, geopolitical headwinds

US growth has remained notably resilient despite a steady drumbeat of bearish narratives. Outside of a US President Trump-linked dip in the first quarter 2025 and a government shutdown–related slowdown in Q4, activity has been robust. Forward-looking indicators and forecasts (including our own) point to sustained momentum, underpinned by solid consumer spending, strong corporate earnings, and large-scale investment—particularly in AI and the potential positive impacts from tax legislation, such as the One Big Beautiful Bill Act. That said, the macro backdrop has been repeatedly challenged by shifting concerns: geopolitical tensions, renewed debate over Fed independence and leadership, fears of a more pronounced “K-shaped” economy, rotation out of AI-linked equities, and most recently, rising oil prices tied to escalating Middle East tensions. While higher gasoline prices will squeeze consumption, the impending fiscal stimulus should offset part of the drag. Meanwhile, the AI‑driven capex cycle remains intact. Our above-consensus forecast of 3.0% for 2026 US GDP growth now faces some downside risk. While the risk of recession is no longer negligible, it remains a tail risk. The more likely outcome we see is slower growth, not contraction, with the structural expansion still intact.

On the AI front, adoption continues to accelerate domestically, and the United States is also leading globally. In prior quarters, companies meaningfully embedding AI outperformed as investors priced in productivity gains, cost efficiencies, and margin expansion—expectations increasingly supported by some early financial evidence. However, despite strong Q4 2025 earnings, AI adopters underperformed during the latest earnings season. In our view, that disconnect reflects a change in narrative; the emergence of pure‑play AI vendors such as Anthropic has shifted market sentiment from broad enthusiasm to more selective scrutiny, with investors increasingly distinguishing between AI beneficiaries and those vulnerable to disruption. This trend is clearest in software, where the market sees AI-powered code generation as a real threat. Companies that don't traditionally work in AI can now build their own software instead of paying software companies for it.  Ultimately, we agree that software and AI will coexist, and the firms that successfully embed AI will be best positioned to outperform. Earnings calls suggest AI is already being embedded directly into workflows, especially agentic AI, supporting the view that software and AI are more likely to coexist than displace one another. Moreover, bearish arguments also often understate software’s high switching costs.

Concerns around hyperscalers’ shift toward debt-funded AI investment are premature. Hyperscalers are doubling down on record data-center capex. The five largest US cloud and AI infrastructure providers have collectively committed to spending close to US$700 billion on capital expenditure in 2026, nearly doubling 2025 levels. Given the scale of future AI investment (US$3 trillion–US$5 trillion), hyperscalers are increasingly expecting to tap debt markets to bridge the gap between rising AI capex and internal free cash flow, thus marking a fundamental shift from historically cash-funded business models into ones utilizing leverage. While this has raised investor concern (visible in credit default swap spreads) given AI’s already heavy footprint in equities, hyperscaler balance sheets still remain very strong and largely net cash positive. Moreover, this shift can essentially be viewed as a rational matching of long-duration assets with long-term funding rather than a sign of financial stress. For now, we believe the narrative of debt-driven AI investments looks of little merit.

Why does the AI story matter for households and the broader economy? Even though consumer spending remains the backbone of growth, a meaningful share of recent upside surprises in growth reflects AI investment and AI‑driven asset price gains. AI‑related equity gains have reinforced a K‑shaped consumption pattern, with households of higher‑income, older individuals—particularly those over the age of 50—driving spending through wealth effects even as the labor market has softened. As of the third quarter of 2025, households of people 55+ owned nearly 80% of US equities and mutual funds, with those over age 70 especially exposed; younger households are more exposed than in the past too, with equities at a record 32% of financial assets for under‑40s, reflecting increased participation during the pandemic and the AI-led rally.

The Middle East conflict has reintroduced an energy shock into the eurozone macroeconomic outlook, raising inflation risks and weakening the near-term growth profile. Inevitable comparisons are being made to 2022 and Russia’s full-scale invasion of Ukraine to assess the potential economic implications of this crisis. We believe that the current backdrop is meaningfully different and will be less severe, subject to the duration of the conflict and the persistence of energy price rises.

Two factors support our view. First, the supply-side shock that followed Russia’s invasion coincided with post-pandemic reopening dynamics, characterized by pent-up demand, elevated excess household savings, a very tight labor market and impaired supply chains, which compounded the inflationary impact. Second, Europe’s energy position, while still vulnerable, is stronger today than four years ago. Gas supply has diversified and LNG imports have increased, especially from the United States, which now accounts for 25% of total gas imports (mostly via LNG) compared with about 3.8% from Qatar in 2025.¹ Renewables’ contribution to energy supply has also increased, albeit still modestly and unevenly, with France and Spain less reliant on oil and gas than Germany and Italy.

As a result, the risk of outright shortages appears much lower than it did in 2022. That said, these conditions do not make the region immune and risks remain high, with the overall macroeconomic impact primarily dependent on the duration of the conflict and the persistence of energy price increases.

Inflation looks likely to reaccelerate this year, but unlikely to spiral out. The inflation effect will be felt first and most clearly through the energy channel. Oil and gas should pass through relatively quickly into transport fuels and gas and electricity bills, lifting headline inflation within three months to the 3% area. Food inflation could also firm again if higher fuel and fertilizer prices, which transit through the Strait, raise agricultural costs. At the core level, the pass-through crucially depends on the persistence of the shock. Goods prices may see some delayed impact, including via rising imported intermediate inputs prices (for example, from China), given the global nature of the shock. Services prices will see the slowest readjustments, as wage formation is very slow in the European Union (EU).

Even so, unless the energy-related shock becomes both larger and more persistent, transmission should be less powerful than in 2022. One important caveat is that several governments have announced potential interventions to combat higher pump prices and/or energy bills. While measures are still being discussed and will likely vary across countries—from income support to price caps—they could reduce inflationary pressure, depending on their structure.

Overall, we are likely to see a renewed increase in headline inflation this year, with the harmonized index of consumer prices averaging between 2.5%-3% in 2026, depending on energy prices, with monthly peaks likely to exceed that level, and a slower return to the 2% target over the next couple of years.

Growth: No recession, but disappointing growth. At this stage, we expect the growth consequences of the conflict to be consistent with a slower recovery rather than a recessionary outcome. Higher energy prices are expected to weigh on household real incomes, delaying the consumption recovery that had been expected this year. Rising energy costs could also preclude the savings rate from declining as quickly as previously anticipated, particularly if uncertainty remains elevated. For firms, a renewed rise in input costs and weaker visibility on demand could restrain investment intentions. External demand may offer a limited offset, given that this is a global shock and will also likely weigh on trading partners. For the eurozone, this is particularly relevant given the ongoing competitiveness challenge faced by parts of the manufacturing sector, where energy costs remain structurally high relative to key global peers.

Nonetheless, there are mitigating forces. German fiscal expansion is already underway and should continue to support infrastructure and defense-related spending. Moreover, during the last energy shock, fiscal support measures worth 3%-4% of GDP (country dependent) were put in place to shelter more vulnerable households and energy-intensive firms. We expect some form of fiscal cushion to be put in place again. 

On balance, although the economic outlook is less compelling, we would expect eurozone growth to remain sub-trend but resilient, averaging around 1% in 2026, with downside risks increasing if the shock extends into the second half of the year.

ECB: A potential upward adjustment may come. The ECB left rates unchanged at 2% in March while evaluating the unfolding energy crisis. ECB President Christine Lagarde struck a relatively neutral yet careful tone, reiterating the ECB’s long-standing data-dependent approach. A stagflationary scenario, with different intensities, was depicted. Upside risks to inflation are obviously being driven by energy, but attention is already being focused on "propagation" through inflation expectations, wage formation and supply chain disruptions affecting input costs. At the same time, downside risks to growth were stressed.

Forecasts included various scenarios depending on the intensity and length of the energy crisis. At current prices, the ECB expects headline inflation to reach the 4% area in the third quarter, with core inflation peaking at 2.8% by the first quarter of 2027, before both normalize over 2027 and 2028, while growth may stall for most of 2026 before recovering thereafter. The ECB considers itself to be "well positioned" to respond to the shock, suggesting a shorter reaction function to inflation than in 2022, when quantitative easing and forward guidance delayed the hiking cycle. Crucially, the situation remains dependent on developments in the conflict, as well as the fiscal reaction from governments and the EU, which are aligning to cushion the impact on consumers and firms; in 2022-2023, approximately 3%-4% of GDP was spent on energy subsidies. However, if energy price pressures were to remain similar to today's levels by June, we cannot exclude a brief upward readjustment in rates by the ECB (circa 50-basis points) in the summer/early autumn.

The more durable market implications may lie beyond the front end of the yield curve. Another round of fiscal support would add to already-elevated sovereign and supranational issuance, while higher interest costs continue to worsen fiscal arithmetic. In that context, the combination of heavy supply, fiscal pressures and structurally softer demand for duration remains a consideration for the long end of the curve. More broadly, this episode reinforces our view that the eurozone is operating in a more volatile post-pandemic inflation regime, one in which geopolitical and supply-side shocks should continue to support higher yields than prevailed during the low-inflation period of the previous two decades.

Japan’s latest data reinforce a “slow and steady” growth story, with policy—especially on the fiscal side—now at the center of the outlook. Revised fourth quarter 2025 GDP rose a solid 1.3% quarter/quarter (q/q) seasonally adjusted (sa) annual rate, driven by robust domestic demand; private consumption and private investment were positive on a q/q basis, residential investment rebounded (4.9% q/q sa), and inventory dragged (-0.3 percentage point contribution to growth). Net trade was broadly flat, with both imports and exports falling 0.3% q/q sa. We see the risk that a drop in services exports primarily driving the weakness, despite still-solid goods exports into year-end. At the same time, the GDP deflator rose for the 13th straight quarter and unit labor costs were up (0.6% q/q sa), pointing to more entrenched inflationary pressures domestically.

Looking into early 2026, we see encouraging signs that momentum is firming. Real household incomes have recovered as slower inflation has aided real wage growth, and Japan’s composite Purchasing Managers’ Index rose to 53.9 in February. We note that over the past 20 years, the reading has only been higher during only six months—implying solid underlying growth in the first quarter. Trade is also reviving. January export volumes rose 8.6% month/month sa, with a notable pickup in exports to China ahead of the Lunar New Year, and auto export volume to the United States has also continued to recover. Even if US tariffs settle at 15% following the Supreme Court’s ruling and US President Trump’s latest announcement, we see little change to Japan’s exports given autos currently remain at 15% post the bilateral agreement, and sectoral tariffs are unaffected. That backdrop is why our outlook for 2026 and 2027 hinges on a steady growth trajectory led by domestic demand and policy. While finer details are still awaited, we are factoring in a cut in consumption tax of food to 0% from April 2027 after the Liberal Democratic Party’s decisive victory, which should boost GDP by at least 0.2% that year. Even without it, we see growth holding up strongly in 2026, contingent on continued wages and price hikes that support household income and corporate earnings.

We also maintain our view that capex continues with a tilt toward software spending to increase productivity amid weak demographics and labor shortages. On the fiscal angle, Prime Minister Takaichi has emphasized policy will not be “reckless” and that the onus is to keep debt in line with economic growth, so the debt-to-GDP ratio comes down, while still cutting taxes across food and drinks and energy and ramping up investment in health, infrastructure and AI. Overall, we expect domestic demand, spearheaded by policy, to steer growth in 2026 (our full-year GDP at 0.8% year/year [y/y]) and lift 2027 to 1.0% y/y with a boost from the consumption tax cut if delivered.

On inflation, since December we have characterized Japan’s dynamics as policy-led disinflation. The core Consumer Price Index (CPI) cooled to 2% y/y in January (from 2.4%) amid slower food price inflation and the scrapping of the provisional gasoline tax, while energy prices fell to -5.2% y/y. Policy measures such as free high school tuition fees and caps on medical fee increases have also kept a lid on services costs, even as some categories remain sticky. We expect subsidies for gas and electricity (January to March) to push core CPI below 2% between February and May, potentially as low as 1.5% y/y by May, before a gradual pickup. Overall, we will keep an eye on second-round effects to inflation owing to higher crude oil prices due to the Middle East crisis.

Beyond the first half of the year, we expect stickier services price inflation as wage gains become more entrenched, and our outlook is for core CPI to slow to 2.0% y/y in 2026 from 3.1% in 2025. A further reduction in 2027 starting in the second quarter is possible as we factor in a cut in food consumption tax, but we will await more clarity on that in the coming months.

We expect BoJ policymakers to look through the near-term inflation downside as temporary and focus on underlying price momentum. The Middle East situation is a risk for the economy and could present a stronger case for the BoJ to hike in April, after they let rates remain unchanged in March. Proposed BoJ Policy Board appointments (Professors Asada and Sato) appear aligned with the reflationary camp, but we see them as not materially altering the trajectory given the outgoing members were also dovish. We stick to our call for a rate hike in April soon after initial Shunto results, followed by one more interest rate hike likely in October, taking the policy rate to 1.25% by end-2026 and at least 1.50% by 2027.

In rates markets, we retain a mildly bearish stance on Japanese Government Bonds (JGBs). While long-end bonds have recovered, we see risks of continued volatility and a re-steepening of the curve as fiscal steps come into focus, even as foreign investors continue to buy JGBs.

Currency outlook

US dollar (USD)

Renewed geopolitical tensions have reaffirmed the USD’s safe-haven status. However, it is no longer the clean macro story it once was. The currency will likely remain structurally capped and vulnerable to “noise” from elevated policy uncertainty; the issue is not weakness in US growth per se, but the absence of policy momentum. With the Fed, at least for the time being, no longer in a tightening phase that compels capital to chase higher US yields, the dollar’s cyclical profile has changed.

In prior tightening cycles, widening rate differentials were a powerful mechanical driver of USD strength—higher short-end yields relative to peers attracted fixed-income inflows and reinforced the “US exceptionalism” narrative. In 2026, that dynamic has softened; even if US data remain resilient, markets do not expect aggressive tightening, so without expanding differentials, the USD lacks the impulse that previously drove it higher. Consistent with that view, the dollar is trading largely in line with where two-year rate differentials would imply; therefore, there is no significant mispricing that demands a sharp corrective rebound.

Policy “noise” is distorting fundamentals—trade policy risks, renewed geopolitical tensions and speculation around Fed independence and succession have injected persistent uncertainty, alongside episodes where the dollar underperforms even when spreads suggest it should be firm.

Relative equity performance is a critical variable. For years, consistent US equity outperformance attracted foreign inflows and acted as a strong medium-term anchor for the currency, cushioning it even when rate differentials narrowed or political noise increased. Today, that pillar is no longer unquestioned. If global ex-US equities continue to close the gap—a trend that started in 2025—the mechanical inflow advantage that supported the USD weakens. While this does not imply capital flight, it does mean a normalization of global portfolio allocation, which could meaningfully alter USD dynamics at the margin, particularly in an environment where yield support is capped.

Prior to the Middle East conflict, we would have said the path of least resistance for the USD is modestly lower unless we saw a clean resolution of trade uncertainty and/or renewed US equity leadership. However, for the time being, the USD will continue to find some structural support via safe-haven flows.

Euro (EUR)

The direction of the energy shock is likely to be negative for the euro, but the magnitude may remain contained. Higher energy import prices represent a terms-of-trade deterioration and, therefore, a drag on regional income. In addition, periods of geopolitical stress typically favor the US dollar through safe-haven demand. Both channels argue for some pressure on the euro.

However, a more significant and sustained depreciation appears less likely than in 2022. The shock is more global, the eurozone’s energy vulnerability has moderated, and recession risks remain relatively low at this stage. Moreover, interest-rate differentials may not move against the euro if the ECB is forced to remain cautious on easing. In this setting, we would expect EUR/USD to remain biased lower in periods of acute risk aversion but still seeing a more range-bound profile as the more likely outcome, absent a material escalation in the conflict or a much larger move in energy prices.

Japenese yen (JPY)

After a brief rally in the yen following the election results, USD/JPY was quick to turn around on the back of strong US data and a less-dovish FOMC tone in January. Market speculation about the Japanese government’s push to encourage the BoJ to keep rates low has also worsened the yen’s performance.

The JPY was down again following the Middle East conflict, especially as Brent crude oil surpassed UD$100/per barrel. While the yen generally is favored as a safe-haven currency, especially in geopolitical-risk situations, Japan’s own reliance on imported oil from the Middle East points to risk. While the reliance on fuel imports has reduced, it is still 20% of total imports, which to some degree should offset safe haven gains for the yen.  

We think fundamentals still align for a stronger yen, especially as the BoJ progresses on rate hikes. We are also seeing the correlation between USD/JPY and five-year rate differentials become positive again after breaking down from mid last year on tariff-related uncertainty. We think that the stabilization in long-end JGB yields could be a factor which has also helped support the yen. While still early, a narrowing in the five-year spread (given our expectations of two rate hikes by Japan versus one or no cuts by the US in 2026), could result in downward pressure on USD/JPY.

For a prolonged or sustained yen recovery, we will need to see more concerted BoJ rate hikes, less worry over fiscal expansion and more supportive inflows, all of which are currently lacking. We therefore retain our bias for the yen to stay at current elevated levels for longer, with patches of volatility on either side.