Key Message
The global economy continues to surprise on the upside. Growth remains above trend and is becoming increasingly broad-based: strong technology capex is now being complemented by a recovery in non-tech investment, while the sectoral and regional breadth of the August PMIs is particularly encouraging.
That said, the improvement in labour markets is still based on limited evidence and comes against an underlying backdrop that remains relatively weak. It is therefore too early to conclude that a sustained turning point has been reached.
Executive Summary
The August global composite PMI is consistent with annualised growth of around 3.1%, compared with an already solid 2.5% in the first half of the year. The energy shock remains in place, with oil once again approaching USD 100 per barrel in the absence of a lasting de-escalation in the Middle East, although the drag on global growth appears manageable at current levels.
The key question is whether this resilience in activity translates into stronger labour income and purchasing power. The August data are encouraging, but not yet conclusive. The global employment PMI rose to its highest level in three years, while in the US, hours worked in cyclically sensitive sectors, goods, distribution, leisure and hospitality have increased at a 1.3% annualised pace over the past six months, the strongest rate in more than three years.
However, aggregate global employment growth remains subdued, at around 0.5% annualised in mid-year, while the August rebound follows a disappointing July reading that had already tempered expectations. For now, this should therefore be viewed as a positive signal that still requires confirmation, rather than as an established trend.
My base case assumes that the current improvement is sustained, and that labour income benefits from a tighter labour market, but this remains a working assumption rather than a confirmed development.
The balance of risks has therefore shifted. The main concern is no longer a sharp slowdown, but rather a combination of resilient growth, persistent inflation and a firmer labour market. This gives central banks less room to ease policy.
In the euro area, resilient activity, with the final August PMI pointing to annualised growth of around 1.4%, is coinciding with underlying inflation that remains above target, with August inflation rising to 3.3%. This makes a 25bp ECB rate increase next week highly likely.
My base case is that this will be a one-off move. I expect inflationary pressures to moderate without meaningful second-round effects, which should limit the need for further tightening. This stands in contrast with money markets, which are currently pricing in two additional increases beyond this move.
In Japan, fiscal policy is becoming increasingly expansionary, with FY27 budget requests up 17% year on year. This is adding to inflationary pressure and raises the risk that the BoJ ultimately tightens policy more than we currently expect.
In the US, the Fed still has room to wait. The August payrolls report was noisy, but stronger than expected, and the probability of a September hike has risen to around 50%. At present, however, the balance remains finely poised.
Near-Term Focus: Central Banks
Until the next earnings season, roughly one month from now, provides a clearer read-through from the corporate sector, central banks are likely to remain the main market catalyst.
This week, attention is focused on the ECB. A 25bp increase is largely priced in, so the more important question will be how the move is framed: whether it is presented as an isolated adjustment or as part of a broader tightening cycle.
My view remains that it will be the former. The combination of firmer activity data and inflation at 3.3% justifies a rate increase, but I do not expect this to mark the beginning of a sustained series of hikes.
The Fed meets the following week, where the outcome is considerably less certain. I nevertheless continue to expect at least one further rate increase during 2026.
The recent rise in sovereign bond yields has also created some concern, but I see limited evidence of a broader fiscal or credibility crisis. In my view, the move can be explained overwhelmingly by a reassessment of the monetary-policy outlook rather than by a deterioration in perceptions of sovereign solvency.
Key Risk
The main risk is that the same combination of sticky inflation, firmer labour markets and higher rates is now interacting with a corporate investment cycle that is becoming increasingly dependent on credit.
Historically, abundant credit, elevated asset valuations and central banks moving towards tighter policy have often been associated with episodes of financial stress.
Central banks’ willingness to remain patient during the energy shock has been an important support for risk assets. Their shift towards tighter policy now introduces a second-order risk that should not simply be extrapolated away as part of an otherwise benign growth environment.
Conclusion
The dominant macro risk is no longer a sharp deterioration in growth. It is that resilient activity, firming employment and persistent inflation force central banks to maintain restrictive policy for longer than markets currently discount.
At the same time, that restriction is being imposed on an investment cycle that is increasingly reliant on credit. This is where the principal tail risk now lies, and it is the area that deserves the closest attention.