In our newsletter before summer, we were sceptical of the optimism then surrounding the Iran war. It was said Iran and the US were close to some kind of deal. We did not expect such an agreement to hold and predicted a messy period ahead. Unfortunately, we were right. Economic warfare as well as bombings are back on the agenda. At the same time, the trade war is resumed, now with Canada as the target. And rising government debt spurs fears of future financial repression.

Given this mess, it’s a small wonder that the global economy is doing as well as it does. Markets seem to have a way to adapt rapidly and with flexibility. And in Sweden, growth has finally picked up speed!

Economic warfare
The US failed in breaking Iran via military pressure. Negotiations also failed. Now the Trump administration reverts to harsher economic pressure. Secretary Bessent has talked about “Economic D-Day”, implying sanctions not only directly against Iran, but also on all other agents doing business with Iran.  But he was short on details, obviously not wanting to upset financial markets.

We understand him. If he and the president really were to live up to their tough rhetoric, they would need to declare economic war to several sovereign countries, companies and financial institutions, including China, Hawala networks and a great number of banks. Such a war would hurt Iran but would backfire and hurt the US as well. China will not back down.

Looking ahead, it is difficult to see any de-escalation soon. Facing negative polls and the midterm election, Donald Trump will not be able to achieve any economic “victory” clear enough to rapidly lower prices and interest rates in the American economy. Instead, he will probably go for increased military pressure – and Iran will answer with renewed strikes from their side. The theocratic regime believes time is on their side as American stockpiles of missiles is depleted and domestic support for the war is weaning in the USA.

Still, the oil price is well-behaved, considering the precarious situation. Producers and consumers have adapted better than we (and others expected). China has reduced its imports, while Saudi Arabia has been able to increase exports through pipelines. And it seems that some vessels have been able to sneak out through the Hormuz strait, close to the Oman coastline.

It is impossible to know for how long this may last. As of now, we expect the war (both economic and military) to continue at least for some more months, while the oil price nudges up. Donald Trump will get more desperate to find an off-ramp, but that may make him even more unpredictable.

While all this goes on, the president has opened a new chapter in the trade war with Canada, hiking tariffs and even renaming lakes. This will have only a marginal effect on the US economy, but it underlines that we live in a perilous world, where Trump’s numerous wars and conflicts will continue to disrupt markets and relationships.

Inflation has been more affected than the real economy
In real terms, the effects of the war have not been as detrimental as we feared. The global economy is gradually picking up speed – even in the Euro Zone, we see some gradual improvement. Both investments and private consumption seem to be holding up fairly well.

The effects on prices have been more visible, with inflation clearly above target, both in the US and the Euro Zone. The ECB will hike soon, given its traditional reaction function. As regards the new Fed Governor, Kevin Warsh, he is now facing a test. He fumbled his first meeting and press conference, but after the August meeting, he clearly stated that inflation is too high and must be dealt with. It is reasonable to interpret such a statement as a prelude to a key rate hike, possibly already in September. Stort-term rates have consequently risen, while long term rates have been more stable as markets see Fed credibility improving and some inflationary risks receding.

Three factors have been pushing up bond yields during the summer. Continuing geopolitical worries, stubborn inflation and increasing worries about debt, in particular in the US. As rates have risen mor than inflation predictions, real rates -and the term premium - is the main culprit. Rising government has now been complemented with rising private borrowing as the hyperscalers ramp up their investments in data centers. The present investment wave is dominant and will drive both growth and cost pressures; it will take some time before we may see the strong productivity effects of AI many hoped for. Long-term yields are back to where they were before the financial crisis of 2008-09.

Jitters in the Treasury while stocks continue up
This is creating visible jitters in the American treasury department. Scott Bessent has launched buybacks of treasuries. This is not in itself remarkable; The Treasury is formally in charge of handling government debt; furthermore, this is not quantitative easing, as no new issuance of debt took place.

Nonetheless, the actions very much look like testing the waters for financial repression. Not least since the Treasury at the same time supported JPY – but not by selling treasuries, which was an awkward way of intervening. The USD is weakening as a result, and the “debasement trade” is back – with even Bitcoin rising from the dead as investors look for alternatives to the American dollar. Crunch time will arrive in spring, when the debt ceiling is to be negotiated – possibly with a Democrat-controlled Congress…

Countries as well as companies and banks are increasingly worried about the erratic and egotistical performance of the US administration – the Iran war, the renewed trade war and now looming financial repression. China is pressing her trade partners to use the RMB also for international transactions. The dollar’s pre-eminent position in the global financial system is not threatened – yet. But it is being gradually weakened

Despite all these worries, stock markets are still on a roll. However, they are also vulnerable. Valuations per se are not stretched in general, but there are doubts that cash flow will suffice to pay for all the huge investments in data centres and energy production. Not surprisingly, some volatility is visible. Nvidia is still dazzling, but we are nearing the last legs of the bull market.

Sweden: at last some nice numbers
The Swedish economy is doing better. Inflation is low, exports grow briskly, public consumption as well, and private consumption is helped by pork-barrel tax cuts as we approach the parliamentary election due in September. As a result, GDP growth is now accelerating. Next year, inflation will rise, both because of rising capacity utilisation and the end of some temporary tax cuts.

In this situation, the Riksbank is gradually approaching a rate hike. Strong growth and higher capacity utilisation mean a pre-emptive and careful hike is likely this autumn, with more to come in 2027.

Looking at the election, the opposition (left-green) has a lead in the polls. The government (centre-right) seems to be catching up somewhat, but SDP leader Magdalena Andersson looks likely to return as PM. She does not want to form a coalition government including the Left party (partly because their demands for sharp tax increases, not least on capital). Rather she will try to find support among Greens and the “middle” parties.

If successful, she will try to form a broad-based government based on compromise towards the middle. There are several possible such outcomes, depending on how the election results will affect the strength of the respective negotiation parties. We expect drawn-out negotiations and some hassle as the Left party will put pressure on the SDP not to enter any far-reaching deal to the right.

In this scenario, the SEK is drawn in different directions. On the one hand, stronger growth and increasing capacity utilisation pushes the krona stronger; on the other, a relatively low Swedish key rate will pull it lower. The net result is difficult to predict, but if the Riksbank hikes as we believe, the SEK should be able to recover somewhat from its recent weakness.