Compounding Costs

Across the world, nations are dealing with rising costs from energy and debt service. These costs are compounding as time goes on.

The conflict in the Middle East has settled into a prolonged stalemate, while kinetic activity in the Russia-Ukraine war carries on. Combined, the losses of energy export and refining capacity have created a global surge in the cost of fossil fuel products. Price pressures have broadened beyond energy, adding upward pressure to bond yields and bringing most central banks back to a tightening posture.

This comes at a bad time for governments. Debt service costs are rising just as elected leaders seek more fiscal headroom to support their economies.

Despite these headwinds, advanced economies have maintained momentum. While risks are rising, we expect growth to remain resilient.

See more: Neutral Rates Nosing Up

Following are our outlooks for the world’s major markets.

United States

The U.S. economy continues to perform well. The August employment report showed a surprisingly strong gain of 162,000 jobs, with upward revisions to prior months. Weekly unemployment claims confirm a labor market that is not slowing. Consumer spending has stayed resilient, along with business investment. However, concerns about inflation are weighing on popular sentiment. The August consumer price index (CPI) was little changed at 2.4% over the past year, or 3.4% core (excluding food and energy). Inflation, robust credit demand, and a wide budget deficit are depressing bond prices.
The Federal Reserve could not ignore persistent inflation and the rise in the yield curve, raising the Fed Funds Rate by 25 basis points at its September meeting. We anticipate one additional hike in the fourth quarter, with a risk of further tightening if prices show signs of reheating.

Canada

Canada has risen to new prominence as a target of U.S. trade hostilities. Reciprocal 50% tariffs have been applied to a wide variety of goods. Encouragingly, critical sectors like auto manufacturing and crude oil were not targeted, but damage has been done. The majority of Canadian exports are sent to the U.S., and targeted sectors like dairy and alcohol will feel a pinch. Canada is seeking to diversify its trade relationships, though we do not expect it to become an “associate member” of the European Union.
Canada’s gross domestic product gained 0.8% in the second quarter, its strongest gain in two years, led by an upturn in both residential and business investment. The unemployment rate improved to 6.4% in July and held steady in August, down a half point from its recent peak. Price pressures in Canada are stable, with the headline CPI holding at 3.0% year over year in August. Canada’s ample energy supply insulates the nation from shocks that have other markets on edge. As renewed U.S. tensions have raised downside risks to growth, we expect the Bank of Canada to remain on a cautious hold.

Eurozone

Eurozone nations are feeling pressure from several fronts: low inventories of natural gas raise the risk of concentrated energy inflation through the winter and could impair an industrial recovery. Consumer spending will remain challenged by persistent inflation, which stepped up to 3.2% year over year in August, led by the energy-sensitive transportation category. Higher bond yields are a strain on more heavily indebted nations like France and Italy; this will prevent most euro area leaders from contemplating further measures to support households.
The European Central Bank has not hesitated to act in the face of global inflation risks, raising policy rates in June ahead of the failed Middle East ceasefire. The renewed conflict brought about a second hike in September. With prospects of higher inflation still looming, we anticipate one more hike from the ECB in the fourth quarter. Some policy volatility may be in sight as the French government sets a budget that could spur an election, and the ECB will see new leadership following President Lagarde’s announced retirement.

United Kingdom

Inflation in the U.K. is ascending, climbing to 3.1% year over year in August. Energy was the culprit, with price supports having expired; inflation improved one tenth to 2.5% on a core basis. With the unemployment rate holding steady in the year to date, the cost of living will remain the policy focus. Chancellor Healey will be challenged to find headroom for stimulus in the Autumn Budget, as yields have ascended and 2026 borrowing has exceeded the Office of Budget Responsibility’s March forecast. A contentious budget process could be the tipping point for Prime Minister Burnham to call a snap election to consolidate power.
The Bank of England Monetary Policy Committee (MPC) has yet to join its peers in raising rates. In their split decision to hold this month, the MPC gave hawkish guidance that tightening is likely if energy prices stay elevated. We expect two hikes ahead, which can be walked back next year if inflation settles. The MPC also laid out a plan to run down its balance sheet in the coming eight years, including up to £20 billion of annual bond sales.

Japan

Japan’s industrial sector showed strong export growth in July and August. The rally was not limited to the AI boom, as autos and capital goods also gained. Second-quarter gross domestic product was revised upward to a 0.4% increase. The remainder of the year looks sluggish; wage gains have normalized, and cost of living will continue to pressure domestic consumption. Energy support measures and reduced food taxes will help to manage inflation, but Prime Minister Takaichi will face renewed skepticism of any further stimulus in the face of upward pressure on borrowing costs.
The Bank of Japan (BoJ) has continued its normalization of monetary policy, raising rates in September. Governor Ueda offered comments afterward focused on the risk of inflation overshooting expectations, setting the stage for more policy tightening. However, the Japanese economy is not accustomed to rapid rate movements as it weathers growth pressures. We expect the gradual pace to continue, with two more hikes in increments of 25 basis points each next year. Attention will remain on the value of the yen and the rise in long-end yields, though both the BoJ and Fed raising rates should help to keep the Japanese exchange rate stable.

China

China has been well-insulated from most global challenges, possessing ample strategic reserves of key commodities. However, the nation’s growth outlook has not improved. Policy in the 15th Five-Year Plan to improve consumption and investment will take time to implement; the housing and retail sectors remain moribund. China’s borrowing costs have been tame, with longer-term bond yields falling in the wake of persistently weak data. After a deflationary interval, consumer price inflation is hovering below 1%. Exports remain the sole bright spot, accelerating more than 18% year over year in August, amid relentless demand for technology products. A broader revival of growth will require a concerted investment plan that is only starting to take shape.
President Xi’s visit to meet President Trump produced few tangible outcomes. The trade truce extension of only two months to January 2027 is likely to be extended further. Dialogue may continue, but difficult issues around AI advancements, Taiwan and terms of trade will keep the relationship tense.

Australia

With limited natural reserves and refining capacity, Australia depends on imports for over 90% of its energy needs, making the nation especially susceptible to energy shocks. Inflation is set to rise further from the second quarter measure of 3.9%, and government bond yields are climbing in tandem. The unemployment rate has trended up to 4.6% in August from 4.1% to start the year. The high cost of living and falling property prices have damaged confidence and put domestic demand into a cooler trend.
The Reserve Bank of Australia has been quick to react to inflationary risks, raising rates in March and May; we expect the job is not finished, with one more hike in store this year. With firm inflation even before the Middle East conflict, and a high demand for investment to reduce oil dependency pushing up the nation’s neutral rate, we do not see a path to lower rates in the year to follow.

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