Recent months have been characterised by four international trends. 1) the war against Iran continues, on-off, with disruption to oil supplies and fluctuating oil prices; 2) inflation remains at too high a level in several countries; 3) both policy and market interest rates are rising, due to inflation and political unrest, 4) stock markets have continued to rise, driven by the US IT sector. In Sweden, inflation has been suppressed by tax cuts, while the economy improved. Now, headwinds are gathering, threatening the stock market boom.

War and inflation
Donald Trump continued his pattern of threatening and withdrawing. But the Strait of Hormuz has remained closed, although some ships slip through (at high freight rates and insurance premiums). Oil prices have gone yo-yo, but at a level much higher than before the war and at about 100 USD per barrel on average during the last month. Furthermore, soft commodities like corn are up almost 15 percent and wheat futures are up around 25 percent compared to a year ago, due to Black Sea supply bottlenecks and adverse weather conditions in major growing regions. An important base metal like copper is also up, around 35 percent year on year.

Still, the world economy has proven surprisingly resilient. China reduced its own oil reserves and reduced its imports, and gradually the United States also released some of its strategic reserves. The world economy is not nearly as dependent on oil as it used to be. But now, when price increases have spread to soft commodities and some base metals, we could expect a larger inflation push down the road. Nonetheless, in most Western countries, a cautious economic upturn (albeit from a low level) has been discernible.

Rising interest rates
The supply disruptions have contributed to inflation being stuck at a level well above the central banks' target. A series of interest rate hikes have therefore been initiated, both by the ECB and the Fed.

Higher policy rates, higher inflation expectations and geopolitical unrest all contribute to market interest rates rising sharply. In addition, there is intensified competition for borrowing, especially in the US, as the big tech companies need to fund their investments at the same time as the US government debt is growing. In Europe, it is mainly France that has seen rising interest rates, mainly due to uncertainty about the country's ability to deal with its debt.

Long-term market interest rates are now back at the levels they were 20 years ago, before the financial crisis. Few believe in a decline from here. On the contrary, inflation is likely to force further policy rate hikes at the same time as budget problems increase. The long-term real yield (“r*”) has risen and the market US 10-year real yield is up around 1 percent this year (measured by TIPS).

Booming stocks
Rising interest rates tend to have a negative impact on stock markets, as credit and investments become more expensive, and bonds become an alternative to equities. However, extremely high profits in the tech sector have continued to drive prices upwards. Broad stock market indices have also hit all-time highs repeatedly during the past quarter. The earnings outlook looks strong in Q4 as well.

Nevertheless, concern is growing. The strong upturn is concentrated in a small number of extremely profitable companies. The vast majority of listed companies' stocks have actually declined. In order for the tech sector's profits to persist while the planned investments are paid, a huge increase in the companies' revenues is required. The question is: will demand for their products from other companies increase fast enough?

Headwinds ahead
We foresee rising earnings, strong profits and good performance also during Q4. Further ahead, however, headwinds are gathering.

• Political risk is rising for the AI sector and the tech bros driving it. AI expansion is pushing up electricity prices and huge investments are increasingly crowding out jobs and growth in several other sectors. Increasing income and wealth inequality is causing a tax backlash, with increasing demand for “billionaire taxes” in several countries. On top of that, fear of AI agents going rogue is creating political pressure for stricter regulations.
• A couple of mega IPOs are planned for this winter. Historically, big IPOs push up valuations ahead of the event, but after the IPOs the pattern has been one of falling stocks. Of course, that might not happen this time, but the mere fear of it demands caution.
• Revenue projections are not keeping up with the projected costs of future massive investments. This will either lead to downgrades or to funding gaps which need to be filled by borrowing.
• In the US, the Democrats seem poised to take control of Congress after the midterm elections. During winter, negotiations over the debt ceiling will take place. They could cause a rupture in Washington DC and lead to further market worries concerning the government deficit. Some (including us) believe that “financial repression “, i.e. some kind of capital controls, will be introduced to massage the bond market.
• In Europe, France is unable to tackle its debt problems. Next year, a far-right populist may win the presidential election, causing a row with Germany and the ECB on how to fund the deficit. We cannot exclude a new euro crisis.
• The wars between Russia and Ukraine and between USA and Iran are unpredictable, not the least since President Trump plays an important – and irresponsible – role in both.
• Finally, as bond yields climb and stock markets wobble, more investors will question the TINA mantra which has been in favour of equity markets for a quarter of a century. If government bonds yield as much as stocks but with lower risk, a migration from stocks to bonds will probably occur.

Sweden: Rising economy, rising inflation
The Swedish economy stands out because of its low inflation. In the third quarter, inflation was close to zero. However, the reason is largely temporary reductions in consumption taxes – by a mere coincidence just ahead of the parliamentary election. During winter and in 2027, inflation will rise sharply, above the Riksbank target, both due to rising energy costs and because some of the tax cuts are coming to an end.

Economic activity is improving on a broad front. Exports are doing well, government spending (not least on defence) is increasing, and private consumption has finally picked up.

The combination of rising inflation and higher capacity utilisation has caused the Riksbank to raise its policy rate, and the bank has signalled that the hikes will continue in Q4 and into next year.

One dominant question for financial markets has been the outcome of the parliamentary election past September. The former opposition parties have been given the task by the Speaker to form a new government. As we write this, negotiations are under way. Though the situation is fluid, our best guess is that Magdalena Andersson, chair of the SDP, will eventually form a government which seeks support in “the middle”. Thus, we do not expect the tax hike proposals from the Left part to become part of the government program or budget proposal. The new government needs to tighten fiscal policy after the recent spending splurge.

Conclusion
We are facing a potentially disruptive period. If Donald Trump loses the midterms, he might try tear up the election by calling it fake, firing up his base and starting a prolonged judicial fight. He might also unleash a new round of fire and bombings in the Persian Gulf. Both the ECB and the Fed will hike key rates.

At the same time, the AI-driven tech equity boom is facing increasing headwinds. Strong revenues may keep the rally going a little bit longer, but it seems increasingly stretched. Consequently, we foresee increasing migration by investors from equity into cash, short-term credit and corporate bonds.