Global economy to weather geopolitical headwinds despite tariff risks: Capital Economics

Capital Economics forecasts a global economic slowdown over the next two years, citing US policy impacts and reduced fiscal support in China, though tariffs are expected to have a "fairly modest" overall effect. The report projects US GDP growth to slow to 1.5% with core PCE inflation rebounding above 3%, delaying Fed rate cuts until next year. India stands out as a "global outperformer" with 7% growth, contrasting with China's projected slowdown to 3% by 2026 and Canada's recession risk. Globally, moderating inflation offers central banks room for cuts, yet US tariff-induced price pressures complicate the Fed's stance, while most commodity prices, notably oil, are expected to decline.

Analysis

The global economic outlook presented by Capital Economics points to a period of modest slowdown and significant regional divergence. The United States is forecast to see its GDP growth slow to 1.5% annualized, while a tariff-induced rebound in core PCE inflation to over 3% is expected to keep the Federal Reserve on hold, delaying any potential rate cuts until next year. Concurrently, China's growth is projected to decelerate from nearly 5% to 3% by 2026 due to reduced fiscal support, posing a headwind to global activity. In stark contrast, India is positioned as a 'global outperformer' with a robust 7% growth forecast for the next two years. Monetary policies are also diverging, with the Fed remaining hawkish, the European Central Bank nearing the end of its easing cycle, and the Bank of Japan anticipated to resume tightening. This complex backdrop is further shaped by a forecast for falling commodity prices, particularly oil, driven by increased supply, although tariffs could introduce upside risk for metals. The overall impact of tariffs on global trade is expected to be 'fairly modest', contingent on limited retaliation and successful export rerouting by China.

Key Decisions for Investors

• Given the stark divergence in regional growth forecasts, investors should consider overweighting exposure to India while adopting a cautious stance on China and Canada, which faces recessionary risks from US trade policy.
• The differing central bank trajectories create opportunities for a nuanced fixed-income strategy; US yields may remain elevated in the near term as the Fed holds rates, while the Bank of Japan's pivot to tightening could signal a shift in currency and bond markets.
• The combination of slowing US growth and persistent inflation suggests a stagflationary risk, warranting a focus on defensive US equities and companies with strong pricing power.
• For commodity investors, the outlook suggests a bearish position on oil due to rising supply, while maintaining vigilance for potential tariff-driven price spikes in industrial metals.