End of ‘Pax Americana’ and the investment implications
A weaker US dollar, increasing term premiums are some of the changes expected
WE HAVE just published our annual Horizon report – its 13th edition.
It presents our vision for strategic asset allocation and provides 10-year forecasts for more than 50 asset classes across bonds, equities, alternatives and cash in five currencies. It also delves into some of the key topics we expect will drive markets in the coming years.
Shift in global framework
The world as we knew it is over. The political shift brought by the change of US administration this year is accelerating a structural shift in the global framework that was already beginning to take shape.
For much of the last 50 years, the US acted as the global guarantor of stability. That period of “Pax Americana” is now well and truly over. In its place is a new era where countries are turning inward.
This shifting international framework has investment implications. Asset-allocation decisions made for the coming 10 years are likely to be different from those made for the past decade.
Some of our key conclusions are:
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- The US dollar will depreciate as investors start to question its status as the world’s ultimate safe-haven and global reserve currency.
- US equity market dominance is likely to fade in a less-exceptional environment, leading to continuing diversification away from the United States.
- Private assets are producing stable returns, with private equity poised to outperform public equities.
- Term premiums are on the rise as fiscal sustainability is in the spotlight.
Retrenchment a key theme in emerging world order
Retrenchment, rather than collaboration, is the theme of the emerging world order.
In this new, deal-orientated era, countries assess their capacity to look after their national interests. Where they identify deficiencies, they redress them by forming alliances, often with their neighbours. This is driving a structural shift towards greater regionalism in geopolitical alliances and, by extension, in economic relationships.
Under the old framework, the US delivered economic stability, security guarantees and superior returns in exchange for foreign capital. The compelling, low-risk returns that the country offered under this set-up attracted capital from the rest of the world, allowing it to accumulate its twin current account and fiscal deficits.
As a result, the US’ net international investment position is negative and represents US$27 trillion, or 90 per cent of its gross domestic product.
Now, faltering international trust in that arrangement, exacerbated by its tariffs policy, is increasing the risk of capital repatriation from the country.
Indeed, raising US tariffs with a view to addressing perceived trade imbalances implies a reversal of trade flows, which may in turn bring a reversal in capital flows. At the same time, the US’ ambivalence about its commitment to act as a guarantor of peace and stability has implications for security policy.
This is a big driver of change for the North Atlantic Treaty Organization (Nato) in Europe, where countries are increasing the share of national output they spend on defence. The latest spending commitment by Nato leaders includes 3.5 per cent of GDP dedicated to core military capabilities and 1.5 per cent going to security-related infrastructure projects.
This increased government spending will act as fiscal stimulus, and help to support Europe’s revival.
The increased defence spending goes hand in hand with a new fiscal stance in Germany, Europe’s largest economy. Aiming to hit the goal of spending 3.5 per cent of GDP on defence before many other European countries, Germany is showing a new readiness to engage in fiscal stimulus – a potential “game changer” moment that could spill over across Europe, where lending growth and easing monetary policy are supporting a broader structural revival.
Weaker dollar, higher term premiums
Taken together, the change in US posture vis-a-vis the rest of the world and the European revival represent a shifting of tectonic plates in the global economy and financial markets. This has already led some foreign funds to flow out of the United States.
The clearest manifestation of financial markets’ concerns about the new US posture – both the threats to international cooperation and to checks and balances at home – is the weaker greenback. Though it has long been the world’s ultimate safe-haven and global reserve currency, investors are starting to question its status.
Europe’s revival also means that global investors have more alternatives when considering their long-term currency, fixed-income and equity asset allocations.
Navigating the new era will require a careful, strategic approach, with an awareness of the risks. Investors face a volatile macroeconomic environment in the coming years. There is uncertainty whether trade friction will fuel inflation, as well as upward pressure on long-term interest rates as investor concerns about fiscal sustainability grow, with both the US and Europe projected to experience increasing debt levels.
In this context, the term premium – the extra return that investors expect for holding longer-term bonds compared with holding a series of shorter-term bonds over the same period – is likely to continue rising over the long term.
At the same time, the long-held notion that risk-free interest rates are represented by US short-term Treasury bills is a concept that should now be challenged.
Technological independence, political alliances and Asia’s economic future
The tectonic shifts in the global economy extend to Asia too.
The US’ emphasis on unilateralism and an “America First” approach means that markets such as Taiwan, Japan and South Korea must reconsider their geopolitical risk situation. A reduced US presence in Asia would create space for regional powers to assume greater responsibility in shaping the region’s security architecture.
China has already expanded its influence through initiatives such as the Belt and Road Initiative, and could play a more assertive role in the region. Japan and South Korea, longstanding US allies, may seek to diversify their strategic partnerships while enhancing their own defence capabilities.
The adjustments in US engagement in Asia coincide with technological advancements in China that exacerbate the rivalry between these two nations. China’s innovations in artificial intelligence present countries with a stark choice that will define their technological independence, political alliances and economic future: to align with US or Chinese technology, or attempt the delicate dance of using both.
This divide will extend beyond hardware to digital governance, data security and cyber norms, forcing countries to make difficult choices that could shape their economic futures.
The race for ascendancy in technology extends to electrification, which is being spurred on by global warming. Countries are progressing at different speeds in this domain, particularly when it comes to electric vehicles (EVs). Thanks to a highly proactive policy, China has established uncontested leadership in almost every segment of the energy transition value chain, including EVs.
The world’s economies face this volatile economic outlook, laced with geopolitical rivalry, at a time when they are grappling with growing demographic challenges at home. Population decline and shifting migration patterns are combining to alter growth prospects, labour markets and inflation dynamics across regions.
These pressures will reshape economies in the coming decades. Those that thrive will find new ways to grow with fewer workers and more retirees in a rapidly changing global landscape.
In conclusion, we are convinced that understanding the risks and opportunities of this changing world order will be crucial for those involved in asset allocation and portfolio construction in the coming years.
We believe the starting point of any investment journey should be to grasp the interconnection of the rapid changes in the geopolitical, financial and technological landscape that we are experiencing in the world – post-Pax Americana.
The writer is chief executive officer, Pictet Wealth Management Asia
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