Geoeconomic fragmentation

President Trump wants to cut both taxes and the US’s fiscal deficit, but it appears the latter will make way for the former. The potential implications include increased inflationary pressure and higher Treasury issuance, which could stoke debt spiral concerns and force recessionary or stagflationary market outcomes. Meanwhile, a shift towards higher fiscal spending in Europe is being well received given its growth implications. China is also maintaining a pro-growth fiscal stance as it seeks to propel domestic demand.

Global recessionary risks have diminished, but the negative impacts of higher tariffs and geoeconomic fragmentation are yet to be borne fully. The destabilising speed of policy adjustment is also affecting sentiment across the consumer, investor and corporate sectors, particularly in the US. This warrants a reassessment of relative valuations and risk-adjusted return potential across asset classes and regions.

Price pressures remain sticky in some markets due to **long-term inflationary trends. US government policy is also keeping the Fed cautious, despite inflation data having surprised on the downside recently. Monetary policymakers’ reluctance to stimulate markets without economic deterioration will likely remain a key theme this year. Meanwhile, Europe is on a disinflationary trend that has allowed the ECB to shift to a more accommodative stance and China is battling deflation with growth stimulus.

Managed decoupling is occurring across regions and strategic sectors globally. The US is pushing for reliable supply chain allies and pressuring those it considers hostile, while China is seeking to reorient its economy towards consumption and Europe is taking steps to enhance its strategic autonomy. Ongoing conflicts also hold the potential to affect markets through channels like energy prices.

**The dollar has weakened this year, despite favourable interest rate differentials. This decoupling suggests **an element of capital flight, perhaps understandably given the US’s decision to weaponise capital control and trade policies over recent years. It also reflects idiosyncratic factors outside the US, such as rising yields in the Japanese bond market (a key carry trade funding source).

The idiosyncratic nature of current macro uncertainties is leading investors to question the validity of traditional safe havens. Capturing returns while also preserving capital will therefore require a more flexible investment approach focused on downside risk mitigation and the utilisation of resilient drivers of return.

Macroeconomic uncertainty is a key component of the equity risk premium, which remains suppressed relative to history. Any normalisation higher would act as a headwind against valuation expansion, making other drivers of returns, such as income, more important components of total returns.

Shifting macro dynamics are forcing investors to constantly rethink their approach to diversification. For example, fixed income returns have become more correlated with those of equities, so new sources of stable and uncorrelated returns are required to bolster overall portfolio stability.

Binary risk events have the potential to force rapid evolution of the investment backdrop, making it difficult to position portfolios for the long-term with confidence. This reinforces the need for nimble, flexible and diversified allocation strategies. In-depth research should also be used to build resilience into portfolios from the bottom up.

In an era of **geoeconomic fragmentation characterised by shifting market dynamics and elevated concentration risks, investors may have to look beyond passive US and global exposures to achieve their return and risk objectives.

Investors with extended horizons who can bear the risks associated with short-term market volatility can benefit from the longer-term opportunities that such environments create. As Warren Buffett once said, it is wise for investors “to be fearful when others are greedy and to be greedy only when others are fearful.”