“If you had asked me back in February, I would have taken a much more pessimistic view of the war’s impact on the global economy. But that would have underestimated the resilience global economies have shown, which has been quite impressive,” says Chao.
To illustrate his point, Chao highlights the manufacturing purchasing managers’ index (PMI) data as of the end of May, which has been healthy across the board even after the war broke out. Although growth estimates for major economies have been revised down for 2026, forecasts are expected to be revised higher in the coming months.
Overall, resilience is evident across various regions. Europe’s vulnerability to the energy shock has not curtailed consumer spending in the Eurozone. In China, the economy delivered a stronger-than-expected 1Q2026, supported by industrial output and export growth. While it remains a major importer of Middle Eastern oil, China’s gradual shift towards clean and alternative energy has helped reduce its dependence on hydrocarbons.
Japan has also performed better than expected — this is supported by the prospect of significant fiscal stimulus from Sanae Takaichi’s administration. Invesco expects the stimulus to flow more meaningfully into the economy over the coming quarters and into 2027.
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Photo: Invesco
Citing the Citi Global Economic Surprise Index, Chao says global economic surprises have been positive for over a year, even throughout the Middle East crisis. This is due to several factors, the first being consumer resilience, with spending continuing in the US, Europe, and certain parts of Asia on the back of low debt levels. “Since the 2008 financial crisis, we haven’t seen such low levels of leverage, which gives consumers more buffer against challenges like higher energy prices. This is further supported by growth in real wages,” he adds.
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Corporations have also remained resilient. Balance sheets are generally healthy, leverage is low, and companies have continued to invest in capital expenditures. This has supported earnings growth in the first quarter, says Chao.
Central banks unlikely to hike as much as markets suggest
In 2026, market disruption appears to have been more inflationary than a hit to economic activity, presenting a dilemma for central banks. Market pricing has shifted substantially, with most central banks expected to hike rates or keep policy on hold. In Invesco’s view, however, the Bank of Japan may be the only major central bank to raise rates this year. For one, US Federal Reserve chairman Kevin Warsh’s first meeting in his current role on June 17 ended with no change in interest rates, although future hikes are possible.
Chao says that the Fed remains caught between its dual mandates — the labour market is still robust, with recent non-farm payrolls coming in stronger than expected. At the same time, inflation remains above target — higher energy prices have lifted headline inflation, while core inflation is still closer to 3%, above the Fed’s comfort zone.
Given this backdrop, Invesco expects the Fed to stay on hold over the coming months. A key factor to watch will be the impact of the reopening of the Strait of Hormuz on energy prices. While the deal should allow the flow of goods and commodities to normalise, the impact on oil prices is unlikely to be immediate, says Chao.
Although Brent has eased to around US$80 per barrel (US$104), it remains above the level seen at the start of the year, around US$65 per barrel. Invesco’s estimates suggest it could take another two months for the oil market to return to pre-crisis conditions. At the same time, demand to rebuild oil and liquefied natural gas (LNG) reserves is likely to remain strong, particularly from countries caught off guard by the recent disruptions. As a result, Chao believes that commodity and energy prices could stay elevated for the rest of the year.
In Invesco’s view, if the Strait of Hormuz crisis eases and oil prices fall in the coming months, the central banks that were previously in rate-cutting mode are likely to return to that posture. The view could change if inflation expectations rise meaningfully higher in response to supply constraints, in which both bond and equity markets are likely to sell off.
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Conducive environment for EM asset outperformance
Global asset performance has been largely positive this year, with cyclical assets outperforming. Chao highlights emerging markets (EM) assets — particularly Asian equity markets — that have been some of the best performers this year. The MSCI EM Index, for example, has provided net returns of 25.61% year-to-date, compared to the MSCI All World Index’s 12.15% and the MSCI World Index’s 10.49%. This is despite Asia’s greater dependence on Middle Eastern oil and energy than on that of the rest of the world.
“There’s a higher level of inflation, and since the region relies disproportionately on global trade, the Middle East war outbreak certainly throws a wrench into that global macro growth backdrop. That double whammy should have translated into more stiff headwinds than what the market showed, so why did we see resilience in Asian markets?” Chao points out.
This is because many Asian economies, particularly in North Asia, have had strong reserves and policy flexibility, explains Chao. Fiscal support and subsidies in markets such as South Korea and India also helped cushion consumers from higher energy costs.
Moving forward, Invesco continues to like EM assets, expecting the global economy to remain conducive to EM outperformance. One factor that would support EM asset performance is a weakening US dollar. In Invesco’s view, the US dollar remains one of the more overvalued currencies on most measures, especially since it did not strengthen much in response to the recent energy shock.
“Before the war, the dollar was already on a clear depreciating trend, whether it was because of the narrowing interest-rate differentials, expectations that the Fed could cut more than other central banks or a broader shift of assets outside the US.
“The reopening of the Strait of Hormuz could restart that pivot in asset flows away from the US — this trend was already visible before the war, but was put on hold during the crisis. We now expect renewed diversification away from US dollars and US equities, especially as investors look for markets with more attractive valuations and stronger growth prospects,” says Chao.
On the correlation between EM equity outperformance and US dollar weakness, Chao notes that there have been few periods when EM equities have outperformed US stocks, based on data since 1952. When it happens, however, three conditions are usually in place.
First, the dollar needs to weaken against a basket of currencies — conditions are ripe for this, says Chao. In fact, EM currencies have already outperformed the dollar year to date and the firm expects the greenback to weaken further, he adds. Second, local central banks need to be on an easing path. With energy prices likely to come down, EM central banks could shift back towards easing, or at least remain on hold.
Lastly, oil prices must be within a manageable range, says Chao. As EM economies are cyclical and vulnerable to higher energy prices, oil typically needs to be in the US$60–US$80 per barrel range for EM to outperform. With oil now trading around US$80, Chao believes the trifecta is back in place. “That is why I’m confident that EM assets, including high-yield and local-currency bonds, could outperform in the second half of the year,” says Chao.
The AI story remains a dominant theme across both markets and many economies worldwide, and Invesco expects this to continue in the coming years. According to Chao, AI hyperscalers — namely Amazon, Google, Meta, Microsoft and Oracle — are expected to spend about US$3 trillion on AI-related functions over the next few years.
South Korea and Taiwan are two markets that have clearly benefited from the AI theme — GDP growth in both markets is accelerating well ahead of expectations. This is due to accelerating export growth and improvements in the consumer side of the economy. Consensus forecasts for MSCI Korea earnings-per-share growth in 2026 are over 200%. In May, exports from South Korea, Taiwan and China were up by about 52%, 50% and 20%, respectively.
Meanwhile, Chao highlights the importance of investment alternatives and calls for diversification. He notes concerns that investors are becoming too concentrated in US assets, particularly in tech.
Amid an elevated geopolitical risk premium, investors could look to private credit, direct lending and direct real estate, whether residential or commercial. “Those assets have shown lower volatility and standard deviation of annual total returns, which means that their returns are more likely and certain, yet they have a pretty average return over the past 20 years,” he adds.
