Overall, the balance of risks appears skewed to the downside. Any further escalation in geopolitics, trade, or tariff tensions could weigh on sentiment, while markets may also become vulnerable if Warsh's hawkish rhetoric is not ultimately matched by policy action.

Selena Ling
Chief Economist & Head,
OCBC Group Research,
OCBC

August was once again marked by a widening disconnect between relatively resilient financial markets and an increasingly uncertain macroeconomic and geopolitical backdrop. Despite the ongoing US-Iran stand-off, rising tensions between the US, Canada and China, and a series of policy surprises, including the doubling of Treasury buybacks and Federal Reserve Chair Kevin Warsh's hawkish remarks at Jackson Hole, US equities continued to rally. The S&P 500 continued to advance, led by technology and AI-related stocks, as strong earnings from Nvidia reinforced confidence that AI investment and adoption remain powerful structural growth drivers.

Fixed income markets, however, struck a more cautious tone. Treasury yields moved higher as investors reassessed the likelihood and timing of further Fed tightening, despite the Treasury's announcement of expanded bond repurchases. Yield curves in several other major markets also steepened, although largely for country-specific reasons. Meanwhile, geopolitical risks remain elevated as markets navigate a more assertive US policy stance ahead of the mid-term elections. Trade tensions are also building, with Washington increasing pressure on key trading partners over issues ranging from forced labour to excess industrial capacity. This bears close monitoring, particularly given the hawkish policy shift articulated by Warsh.

Against this backdrop, global financial markets enter September at a critical juncture. A packed calendar of event risks is likely to shape market direction through quarter-end.

Overall, the balance of risks appears skewed to the downside. Any further escalation in geopolitics, trade, or tariff tensions could weigh on sentiment, while markets may also become vulnerable if Warsh's hawkish rhetoric is not ultimately matched by policy action.

United States

We maintain our 2026 GDP growth forecast at 2.2% YoY, although the weaker start to the third quarter has introduced some downside risk. The second estimate of 2Q2026 GDP growth was unchanged at 1.5% QoQ seasonally adjusted annual rate (SAAR), moderating from 2.1% in the first quarter. Meanwhile, non-farm payrolls came in stronger than expected in August, above market expectations. The unemployment rate remained low at 4.1%, highlighting continued strength in the US labour market. However wage growth moderated to 3.1% year-on-year, the slowest pace since 2021, which seems to suggest that wage-driven inflation remains contained.

We also retain our 2026 headline inflation forecast at 3.5% YoY. July CPI data were relatively benign, with headline and core prices rising by 0.1% and 0.2% MoM, respectively. However, inflationary pressures remain elevated, with headline and core PCE inflation at 3.7% and 3.3% YoY in July.

Against this backdrop, we continue to expect the FOMC to leave the federal funds target range unchanged at 3.50%-3.75% in September. That said, we believe the risk of a rate hike has increased following the hawkish remarks delivered by Fed Chair Kevin Warsh at the recent Jackson Hole symposium. Warsh's speech reinforced the Fed's focus on inflation. He characterised the labour market as stable and broadly consistent with full employment, while arguing that financial conditions were not meaningfully restrictive. More importantly, he emphasised that the Fed's "predominant focus" should currently be on price stability. However, he stopped short of signalling a definitive policy decision for September, stressing that policy should remain data-dependent rather than guided by predetermined forward guidance.

As a result, we view the September FOMC decision as finely balanced. While our base case remains for rates to be left unchanged, we acknowledge that the likelihood of a rate hike has increased.

Euro-Area

We maintain our 2026 euro-area GDP growth forecast at 0.9% YoY. Economic data released during August remained mixed but generally subdued. Retail trade fell 0.3% MoM in June, while industrial production was unchanged and consumer confidence remained weak at -15.5. In contrast, the flash composite PMI rose to 52.1 in August, its highest level since November, pointing to some improvement in business activity.

We also retain our 2026 headline inflation forecast at 3.1% YoY for now. Inflation indicators released during the month were somewhat more encouraging. Producer prices declined 0.3% MoM in June, although they remained 4.6% higher than a year earlier, while the August PMI survey pointed to a further easing in both input and output price pressures. Nevertheless, the ECB continues to view inflation risks as tilted to the upside, particularly given ongoing vulnerabilities related to energy, supply chains and food prices.

As a result, we continue to expect the ECB to raise the deposit rate by 25bps to 2.50% in September, followed by a pause as policymakers assess the lagged effects of higher energy prices and production costs on inflation and economic activity.

The most encouraging development during August was the broadening improvement in business sentiment, with the composite PMI reaching a nine-month high. However, the recovery remains uneven. Household confidence is still depressed, retail trade contracted in June, and industrial output remained stagnant. The minutes of the ECB's July meeting also provided an important policy signal. Policymakers assessed the economy as somewhat more resilient than previously anticipated and judged downside risks to growth to have diminished.

On inflation, however, the message remained more cautious. The ECB noted that the full effects of the energy shock had yet to be fully reflected in consumer prices, while pipeline pressures persisted through elevated producer prices and transportation costs. As a result, policymakers continued to see the balance of inflation risks as skewed to the upside. At the same time, wage growth and other measures of underlying inflation have shown signs of moderation, with little evidence thus far of a wage-price spiral.

Taken together, these developments strengthen the case for one additional insurance hike in September, while arguing against signalling a prolonged tightening cycle. Further rate increases are likely to depend on whether higher energy and input costs begin to feed more persistently into broader inflation dynamics.

Japan

We maintain our 2026 Japan GDP growth forecast at 0.7% YoY. Real GDP expanded by 0.3% QoQ, or 1.1% annualised, in 2Q2026, leaving output 0.7% higher than a year earlier. However, the composition of growth was less encouraging. Domestic demand subtracted 0.2ppt from quarterly growth as private consumption was broadly unchanged and business investment declined 1.2% QoQ. In contrast, net exports contributed 0.5ppt.

More recent indicators paint a somewhat firmer picture. Retail sales rose 4.0% YoY in July, exceeding expectations, while industrial production unexpectedly increased 0.1% MoM, marking a fourth consecutive monthly gain. Against this backdrop, we maintain our 2026 headline CPI forecast at 2.1% YoY, although the balance of risks is increasingly tilted to the upside. Nationwide headline CPI rose 1.9% YoY in July, while core and core-core inflation stood at 1.8% and 1.9%, respectively. More recent Tokyo data showed core inflation accelerating to 1.8% in August and core-core inflation reaching 2.0%. Taken together, these developments strengthen the case for further policy normalisation.

We now expect the BOJ to raise its policy rate by 25bps in September, bringing it to 1.25%. The Bank's communication turned noticeably more hawkish in August. The Summary of Opinions showed several policymakers arguing that, with underlying inflation approaching the 2% target and financial conditions still accommodative, further rate increases were warranted. Some members also suggested that the pace of tightening may need to be faster than markets currently anticipate and that policymakers should respond more proactively to upside inflation risks.

Deputy Governor Himino reinforced this message on 27 August, arguing that the BoJ should continue raising rates as economic conditions evolve. He also warned that exchange-rate pass-through to prices has strengthened and projected CPI inflation above 2% in the second half of FY2026. Against this backdrop, a September rate hike appears more likely than waiting until October or December.

While monetary policy is not explicitly targeted at the exchange rate, yen weakness can have important implications for inflation. The BOJ has argued that the pass-through from the exchange rate to domestic prices appears to be strengthening, providing another justification for further policy tightening. The key question is whether the BOJ will deliver a third rate hike this year, accelerating the pace of normalisation from one increase every six months. Real interest rates remain negative, suggesting that monetary policy is still accommodative and that there is further scope for normalisation.

China

China's economy slowed more than expected in 2Q2026, with GDP growth easing to 4.3% YoY (0.9% QoQ SA) from 5.0% in 1Q2026. Even so, growth averaged 4.7% YoY in the first half of 2026, remaining within the government's 4.5%-5.0% target range. We believe the second quarter is likely to mark the cyclical trough. As policy support increasingly shifts towards service consumption and "Six Networks" infrastructure investment, growth should gradually regain momentum in the second half of the year. We therefore continue to expect China to achieve its official growth target, although we have lowered our full-year growth forecast slightly to 4.6% from 4.7% to reflect the softer-than-expected second-quarter outturn.

The slowdown is not broad-based. Instead, China's economy continues to exhibit an increasingly pronounced K-shaped divergence. The AI sector and advanced manufacturing remain key sources of resilience, helping to offset weakness in more traditional parts of the economy. More broadly, China remains in the midst of a challenging transition from old to new growth drivers. The issue is not a lack of emerging engines of growth, but rather that they have not yet reached sufficient scale to fully compensate for the slowdown in legacy sectors.