Read the reflections with pictures, graphs and tables (pdf)
Continued conflict in the Middle East
On 17 June the United States and Iran signed a temporary agreement that allowed for the gradual resumption of traffic through the Strait of Hormuz. Despite the agreement, the parties were far apart on key issues related to control of the Strait of Hormuz such as Iran's nuclear program, sanctions against the country and the broader conflict in the Middle East, including Israel's continued attacks in Lebanon. The fact that the conflict re-escalated already in early July did not come as a surprise. At present, news of progress towards peace is mixed with threats of new attacks, and it is difficult to determine how much closer we really got to a solution during the summer.
Oil prices have followed the development and for a period approached USD 100 per barrel again. This is significantly higher than before the war broke out, but not really sky-high. Many feared that if the conflict was not resolved by this time, the price would be closer to $200 per barrel. An important reason for why the price is kept reasonably in check is that China has reduced its imports by about 5 million barrels per day and instead used its extensive oil reserves. Global demand has also slowed, while the United States and other countries have increased their production. Although the strait is still essentially closed, oil is currently trading at $80-85 per barrel, reflecting hope for a solution in near time.
One factor that affects the development is the upcoming midterm elections in the United States. The war and the high energy prices are negatively impacting Trump's popularity, thus increasing pressure on the U.S. government to reach an agreement ahead of the election. The Iranian leaders are aware of this, and are probably trying to stay in a strong position for the upcoming negotiations.
Partly new phase in Ukraine
The war in Ukraine has continued during the summer and partly entered a new phase. At the front, changes have been limited and the Russian advance has largely come to a standstill. Instead, warfare has increased in the use of drones and missiles. Kyiv and other parts of the country have been subjected to extensive airstrikes, which the weakened Ukrainian air defenses are finding increasingly difficult to repel. At the same time, Ukraine has intensified its drone attacks, both behind the front line in Ukraine and far into Russian territory. The targets have included oil refineries, energy facilities, military logistics and transport links to Crimea. The attacks have increased the costs of Russia's warfare and contributed to fuel shortages and Russian export bans. The United States, the EU and the United Kingdom have at the same time promised continued military support to Ukraine during the summer.
Extreme weather in several places
The summer has been characterised by extreme weather, with heat waves, droughts, forest fires and floods, and the El Niño weather phenomenon is intensifying in the Pacific Ocean. In Western Europe, the warmest June on record was recorded, with extensive forest fires and record-low water levels as a result. In the Rhine, for example, the low water level has limited transport capacity to 20 percent of normal.
Both Europe and North America, especially Canada, have been hit by forest fires. The fires themselves usually have moderate economic significance at a national or global level, although the local impact and personal tragedies can be enormous. The drought could have larger international effects, which risks worsening the autumn harvests. This is particularly relevant in Africa, Asia and South America, where El Niño is expected to increase in strength, which can affect prices for coffee beans and grain.
Central banks in focus
As usual, most attention was focused on the US Federal Reserve. The newly appointed Fed Governor Kevin Warsh left the policy rate unchanged at 3.50-3.75 percent in both June and July. He underlined the Fed's focus on bringing inflation down to two percent and opened the door to further tightening, which was interpreted by the market as surprisingly hawkish. At the same time, there is disagreement within the Fed, where three of the members at the July meeting voted in favor of an interest rate hike.
Disagreeing views on AI and its effects. Warsh has stressed that higher productivity could dampen inflation and justify lower interest rates, while Williams, among others, has warned that the extensive investments could drive up demand and inflationary pressures, which rather require higher interest rates. However, these perspectives do not have to be mutually exclusive: investment can be inflationary in the short term, but raise productivity and curb inflation in the longer term.
The Riksbank left the interest rate unchanged at 1.75 per cent, which was expected in light of the low inflation in Sweden. On 6 August, however, we received a surprisingly high inflation figure for July, which was the third month in a row with higher inflation than expected. Although we do not believe that the Riksbank is too stressed about this, the probability of a hike during the autumn increased somewhat.
The other central banks in Europe have also remained in place or even raised their key interest rates during the summer. The ECB raised interest rates to 2.25 percent in June and held it flat in July. The Bank of England and Norges Bank left interest rates unchanged at 3.75 percent and 4.25 percent, respectively. It is clear that the interest rate differentials against Sweden will persist for at least a while longer.
Overall, expectations for the interest rates are largely driven by developments in the Middle East. Energy prices will determine whether central banks implement further hikes or gradually return to rate cuts. The market expects higher interest rates, although inflation expectations are still moderate, while we are leaning towards a slightly more dovish development.
Long-term interest rates rose
Long-term government bond yields have continued to rise and reached their highest levels in decades during the summer. The yield on US government bonds with a 30-year maturity amounts to around 5.25 percent, the highest level since 2007. German and Swedish long-term interest rates are at their highest levels since 2011 and 2012 respectively, while British and Japanese interest rates have reached levels not seen since the period 1996-1998.
The development is driven by several interacting factors that have culminated during the summer. More and more people are realising that the years of low interest rates will not return now that inflation and policy rates are stuck at higher levels. In addition, elevated levels of public debt and increased future borrowing needs have contributed to higher risk and term premiums. In addition, more capital has gone into investments in AI, defense and energy, which has reduced demand for government bonds. All in all, this makes it even more difficult for countries' debt financing and many choose to shift their borrowing to shorter maturities, which makes government finances more sensitive to policy rate changes.
No drama around currencies
This summer's movements in the FX-market have been relatively undramatic and have mainly been driven by oil prices, changed risk appetite and expectations of central bank monetary policy. The Swedish krona has weakened by 1 percent against the dollar and about 0.5 percent against the euro.
However, the intervention to strengthen the Japanese yen accounted for the summer's most dramatic currency event. After a prolonged period of weakening, the yen reached around 164 per dollar, the weakest level in nearly 40 years. Japanese authorities, in cooperation with the United States, then intervened by buying yen, which strengthened it to around 157 per dollar.
The intervention has temporarily dampened speculation against the yen, but a more sustained appreciation is likely to require further rate hikes from the Bank of Japan. One reason for American participation is that Japan is the world's largest foreign holder of US government bonds. To finance its extensive support purchases of yen, Japan may have to sell parts of its holdings, which risks pushing up US bond yields.
Strong equities markets
The stock market has generally performed strongly during the summer, where the world index has risen by 3 percent, despite the turmoil in the rest of the world, . The AI theme has continued to dominate the stock exchanges, but the focus has partially changed. After this year's sharp price increases, concerns have increased about high valuations, competition from cheaper Chinese AI models and uncertainty about whether the extensive investments will yield sufficient returns.
The so-called Magnificent Seven companies, have performed weaker than the broader market. The tech-heavy South Korean KOSPI index has lost 30 percent since June, after having risen around 100 percent since the beginning of the year. On certain days, the index fell by between 8-11 percent, forcing all trading to be temporarily paused.
Investors have instead turned to the Swedish and European stock markets, which have been among the summer's winners, with gains of 6 and 4 percent, respectively.
Political developments in Europe
Marine Le Pen, the National Rally, could again run in the French presidential election next year, after a court in July shortened her ban on holding political office. The court ruled that EU funds had been used for party political work in France, but reduced the sentence to 15 months, which had already passed.
Le Pen leads in several opinion polls ahead of the first round of voting and is the favorite in the betting markets, albeit by a small margin. Le Pen is largely a Eurosceptic, and even if a victory for her would not necessarily mean that the EU "loses France as an ally", it would have a much more nationalist-oriented and unwieldy partner in one of its most important member states. Especially on issues such as Ukraine, migration and continued European integration.
The United Kingdom has a new prime minister. Following Keir Starmer's resignation, Andy Burnham, former Mayor of Greater Manchester, took over the post. The Government's first reforms have focused on lowering households' living costs. VAT on household electricity has been abolished, the price of bus travel has been capped at £2 and property tax for pubs has been reduced. The measures are popular and relatively cheap compared to the government's total expenditure, but still take up a significant part of the government's limited fiscal headroom.
At the same time, Burnham has presented greater ambitions in regional self-determination, reindustrialization, housing construction, vocational training, and advocated for increased public control over essential services. How these investments will be financed is still unclear, and in order to succeed, he must show the markets that fiscal responsibility and growth are high on the agenda.
No summer break in trade conflict
Nor did the trade conflict between the United States and the rest of the world take a summer break. The temporary tariffs imposed by Trump after the Supreme Court overturned the broad tariffs from "Liberation Day" expired in July. They were then replaced by new customs duties on the basis of other legal claims. The main argument was that the tariffs would be in response to the use of forced labour, which appears to be a weak justification due to the included countries. Canada was also threatened with separate tariff increases. These were first justified by the fact that smoke from Canadian wildfires polluted the air in the United States, but the motive was then changed to that Canada "discriminates" on goods from the United States.
Overall, this summer's development in the customs area should neither be regarded as an escalation nor a de-escalation. It is mainly a matter of certain types of duties being replaced by other types and the overall tariff levels have not changed more than marginally. We can expect similar initiatives in the autumn, when the often rather far-fetched motives for the tariffs are taken up for appeals and court proceedings. Until new announcements are made, the tariffs that were introduced during the summer will apply, which continue to increase the cost of trade and uncertainty in the world economy.
Now we are beginning on an autumn that also looks like it will be interesting and eventful!
Jens Magnusson, Chief Economist, and Malte Meuller, Economist.