Stagflation light emerges as central challenge
A group of leading economists and macro investors gathered at a roundtable hosted by RBC Capital Markets and KangaNews to discuss the macroeconomic headwinds facing developed economies. The conversation revealed a concerning consensus: while growth remains resilient and inflation has moderated, the global economy faces a persistent, uncomfortable middle ground.
"What worries me most about the stagflation light environment is that it doesn't come with a very strong policy prescription. For a long time, the word economists feared the most was 'recession'. But recession is no longer the scariest type of outlook – to me as an economist or, I would imagine, to investors."
Frances Donald, Chief Economist, Royal Bank of Canada
The particular challenge with this outlook is that central banks lack clear levers to pull, creating a more nefarious economic environment than traditional recessions.
Fiscal pressures and debt sustainability
Beneath the surface of headline stability, structural pressures are building. Developed economies face spending commitments related to demographics, defence, energy transition, and ageing populations at a time when revenue growth is constrained. Australia is no exception, with government expenditure sitting well above its long-run average, leaving limited fiscal flexibility.
"Fiscal and debt concerns have been one of the key negative inputs we have put in our outlooks for the last couple of years, yet markets seem to shrug it off. Maybe this is one of those issues that doesn't matter until it really does."
Su-Lin Ong, Chief Economist, Australia, RBC Capital Markets
Should economies slip further into stagflation territory, debt sustainability becomes a genuine risk for countries with high debt-to-GDP ratios. The bond market, which has seemingly shrugged off these concerns in recent years, may eventually demand higher yields to compensate for this risk.
Tariffs and inflation timing
Much attention has focused on the inflationary impact of tariffs, but the timing remains uncertain. Companies have built inventory buffers and are using bonded warehouses to delay tariff impacts. However, once these inventory strategies exhaust themselves – likely in early 2026 – the pass-through to consumer prices is expected to accelerate materially, potentially shocking markets and forcing a reassessment of interest rate expectations.
AI's uncertain economic contribution
AI offers a potential answer to productivity challenges, but confidence remains cautious. While technology adoption will undoubtedly continue, history suggests short-term impact is often overestimated while long-term impact is underestimated. Early signs show AI adoption affecting hiring patterns, particularly for younger workers, suggesting the economic transition may be more disruptive than anticipated.
Implications for investors
The consensus view is clear: the investment landscape has fundamentally shifted. In this higher-rate, higher-inflation environment, fixed income no longer serves as a reliable equity diversifier. Instead, investors are rethinking portfolio construction, prioritising assets that protect against different economic scenarios while delivering sustainable returns. The days of simple diversification across asset classes are over; nuance and scenario planning are now essential.
The global economy remains on a tightrope, where too much of anything – inflation, growth or fiscal spending – could unravel the careful balance being maintained.
