By Ivan Colhoun, Consulting Economist, Perpetual Corporate Trust
What economists can learn from weather forecasters
A number of years ago, the Bureau of Meteorology gave a presentation on their forecasting methodology to the economics team I was then part of. The key takeaways were: 1) understanding the starting point (the conditions that have given rise to the current weather) was very important; and 2) the forecaster should focus on the biggest forces affecting the outlook.
That structure has helped analyse and forecast the economic outlook as well as proving useful for business planning and budgeting. It’s also important to consider both the longer-term and shorter-term forces affecting the outlook.
The Megatrends
I have been writing for a number of years about what I consider the five most important trends affecting how the economy, business and society might evolve over the next 5-20 years. I suspect most of the items on the list will no longer be a surprise, though when generating the list interactively, the fifth item on the list still rarely surfaces. My top five, longer-term big forces are:
- AI and technology.
- Geopolitics.
- Climate change and the energy transition.
- The ageing population.
- Inequality.
Regular suggestions that I place either outside the top five or subsume under one of the other headings include cybercrime, government debt and deglobalisation. I observe limited onshoring and only partial relocation to friendlier nations (“friendshoring”), which I consider partial reglobalisation, rather than wholesale deglobalisation. There are inter-relationships between some of the megatrends, with AI and technology likely part of the reason behind worsening inequality, and inequality leading to some significant political shifts.
Shorter-term developments
In considering the shorter-term outlook for the economy, we must also allow for the effects of the longer-term megatrends, as well as any other significant forces. At the present time, two of the Megatrends are having a particularly large impact on the short-term outlook, namely AI and the Middle East conflict, the latter appearing under the geopolitics header. The biggest forces affecting the economic outlook over the next twelve to eighteen months in my opinion are:
- AI and technology.
- Geopolitics – the Middle East conflict.
- Continuing above-target inflation in Australia.
- Interest rate rises.
- Recent changes announced in the budget to capital gains tax, negative gearing and the taxation of trust distributions.
The Middle East conflict
Most short-term focus, understandably, is on the Middle East conflict, given the impact the continuing closure of the Strait of Hormuz is having on energy and other raw materials prices – and supplies. An even more extended closure would likely cause much higher prices for impacted products as well as significant supply shortages and rationing. This could result in temporary but significant interruptions to economic activity as occurred during COVID lockdowns.
As we learnt during COVID, when there are supply chain difficulties, the risk is of higher inflation, though importantly on this occasion, demand is likely to be restrained by higher energy prices, not boosted by zero interest rates and significant fiscal stimulus. An early resolution to the conflict – and the avoidance of an extended Strait of Hormuz closure – is likely the most important positive factor for the near-term economic outlook.
AI
Ten weeks ago, AI was the major discussion point in markets, mainly the vast investments being spent but also the business models that AI might significantly impact or render obsolete over time. The AI revolution has of course not gone away with the emergence of the Iran conflict and indeed has continued to be a significant force supporting equity markets in the face of a slower near-term economic growth and higher inflation outlook due to the combination of higher energy prices and interest rates.
AI appears to have both significant short- and longer-term implications. In the short-term, the enormous investment spend and large global data centre rollout program seems set to boost demand for associated products including semi-conductors, electricity, copper and water, all of which are growth supportive but also inflationary in the short-term. In the medium-term, there remains significant uncertainty as to whether AI will destroy significantly more jobs than it creates. If it does, this would be similar in nature to a recession, which would likely create significant downward pressure on inflation and interest rates.
Other shorter-term effects
The RBA has increased interest rates three times in quick succession in the first half of 2026 as Australian inflation remains above target. This reverses the general support for growth and especially the housing market provided by interest rate cuts last year. Changes to taxation and negative gearing announced in the budget are likely to reinforce negative sentiment toward housing in the short term.
Continuing elevated inflation adds further to the cost of living and cost of doing business pressures experienced over the past five years. These have produced relatively pessimistic readings on consumer confidence and somewhat elevated rates of insolvency.
Implications for fixed income and conclusions
It should be apparent that it’s a particularly challenging time to be an economic forecaster with so many large forces impacting the economic outlook. My suggested approach is to consider the pre-Iran conflict economic outlook, with an Iran conflict scenario “overlay”. The pre-conflict outlook overall was reasonably favourable, with growth supported by significant AI investment and last year’s global easing of monetary policy. However, there were signs that inflation was beginning to deteriorate in many countries especially the US, even before the Iran conflict. The latter has added to these emerging inflationary pressures.
Longer-term bond yields are particularly sensitive to inflation trends, with US and Japanese bond yields particularly influential in global bond market pricing. Bond yields have increased across the globe since the Iran conflict as higher energy prices are seen as adding to pre-existing inflationary pressure. In the US, this has also coincided with a repricing by the market from expecting interest rate cuts, to factoring one interest rate rise in the next six to nine months. The market is likely to continue to reprice US interest rates and bond yields somewhat higher in the near term.
The most important near-term development remains the duration of the closure of the Strait of Hormuz. A relatively quick resolution to the conflict would likely see the more favourable economic conditions that were emerging, re-established, while a very extended closure would likely have the reverse impact, significantly lifting energy prices and slowing growth.
If you are interested in understanding how to invest directly in fixed income for your clients, please email Perpetual Digital’s, Head of Institutional Sales and Relationship Management, Emily Boden at [email protected]
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