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Witold Bahrke
Senior Macro and Allocation Strategist
A short Q2 2026 outlook
MACRO: Teflon cycle shrugging off another supply shock
Growth: The business cycle is well-supported by past monetary easing, fiscal stimulus & an accelerating capex cycle. The 2W cease fire between the US and Iran should mark the beginning of a path towards deescalation. Oil is set to decline but remaining above the pre-war baseline, partly removing upside potential to global growth.
Inflation: Temporary inflation boost from energy but no 2nd round effects – provided oil settles below 100 USD/brl. Global inflation remains sticky above most central banks targets.
Policy: Fiscal stimulus remains a tailwind, monetary conditions tightening moderately.
Key risks: A full resolution to the Iran war & sanction removal triggering a positive supply shock & monetary easing. On the downside, a renewed closure of the Strait of Hormuz would cause a double whammy of high energy prices and monetary tightening leading to a recession.
MARKETS: Old habits die hard - buy into geopolitical stress & stagflation fears
Review: Our out-of-consensus expectation of a wobbly H1 (fading monetary tailwinds, stretched sentiment and geopolitical risks) is on track. We went into the Iran war defensively positioned & underweight local EMD.
Turning tactically bullish as geopolitical risks subside: Trump’s low approval ratings & spiking gasoline prices creates sufficient incentive for Washington to de-escalate over the coming weeks. Oil supply disruption should have peaked, accordingly. EM FX set to rebound – overweight local EMD in Q2 as positioning has cleared.
Strategic horizon: We expect high single-digit total returns driven by carry, but also capital gains as hiking expectations give way to limited cuts on a 12M horizon. Higher oil prices means the growth gap between the US and the RoW is moving more in US favour than expected 3M ago: O/W hard currency EMD (RHS chart). Monetary tightening creating a more unstable market equilibrium, arguing for a tactical approach to markets.
Supply shocks keep coming thick and fast (pandemic, Ukraine, tariffs, US immigration, Iran)…
…but the business cycle isn’t budging: Even high-frequent indicators showing no signs of levelling off (LHS).
If our base case of a de-escalation in the Middle East proves to be correct, the capex cycle is supported by declining trade policy uncertainty (RHS).
Cycle maturing, but remaining resilient: Besides capex, past monetary easing and expansive fiscal policy supports growth.
Our expectation of fading monetary tailwinds has been confirmed (LHS), but the pace of tightening is moderating.
Expecting one Fed cut over the coming 12M as growth slows and reaction function becomes more dovish under Warsh.
Oil shock NO game changer as energy intensity has declined, both in EM and DM (RHS), and the overall size of the shock is so far less severe than e.g. the Ukraine invasion.
The world has shifted from structural lack of demand in the post-GFC era to a structural lack of supply in the post-Pandemic era.
This creates an unstable equilibrium in in macro and markets: Regime shifts towards permantly higher geopolitical, inflation as well as fiscal uncertainty implies a more tactical market environment as market cycles become shorter (LHS).
The dilemma: This calls for diversification when diversification opportunities are drying up.
The solution: EMD has been surprisingly resilient – even during the most recent setback as EMD betas to global risk appetite have declined (LHS). This highlights not only EMD’s relative resilience, but also its diversification appeal.
Three signposts to gauge where we are in the sell-off suggest the worst is behind us as a de-escalatory path crystalizes.
We believe the energy supply disruption has peaked as the number of tankers passing the Strait of Hormuz has bottomed – it’s the delta that matters (LHS).
Trump’s approval rating hit new lows (center) → cease fire confirms that the White House is “blinking” & has a desire to de-escalate.
After triggering a risk-off signal earlier in the year, our Risk Index (RHS) is closer to the risk-on threshold than the risk-off threshold.
Bottom-line: In the context of a more tactical market environment as compared to 2025, the set-back in March doesn’t lead to a major repricing of the growth backdrop. Rather, it is an attractive entry point into EMD risk and EM FX risk, in particular.
Shifting from U/W EMFX to a tactical overweight. Key drivers: Positioning has reversed from extreme long positioning (LHS), sentiment is more neutral and we see a clearer path towards de-escalation in the Middle East.
Monetary tightening suggests two-sided risks to spreads at current levels (RHS). Risk-reward in local EMD seem more attractive.
On a 12M horizon, we expect renewed easing, but also softer growth, which should favour hard currency over local currency.
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