Paul Diggle

This is a very challenging environment to make predictions in, and we are conscious many of our scenarios may be seen as negative. Our role as economists is to identify what might fail, this means undertaking robust scenario analysis to rigorously stress test portfolios and understand downside exposures.

Whilst forecasts may miss the mark, the purpose is not perfect prediction but to prepare for potential downturns. From our House View’s medium-term perspective, we continue to maintain signals of positive equities, modestly positive duration, and neutral dollar.

Everything everywhere all at once

Our baseline scenario sees the Iran conflict impart a large but short-lived geopolitical shock lasting two-to-four weeks. We’ve conditioned on the average oil price over March being $90 per barrel (which allows for spot to remain volatile in coming days), falling to $70 by the end of the year.

As a result, 2026 average global inflation is 40bps higher, global growth 30bps lower, and a single rate cut for the likes of the Federal Reserve (Fed) and Bank of England (BoE) is taken out, relative to what would otherwise be the case.

Once the geopolitical shock abates, the macro narrative returns to being one of decent-enough growth, slightly above-target inflation, and modest further central bank easing in some economies. We put a 40% probability on this scenario playing out over our three-year forecast horizon.

Conflict risks dominate

This scenario sees oil and gas flows through the Strait of Hormuz disrupted for months rather than weeks. We’ve conditioned on oil prices averaging $120 over March, remaining above $100 for six months, and still above $80 by year-end.

The recent experience of high inflation means inflation expectations are less well anchored than normal. So central banks do not “look through” this shock, with cutting cycles abandoned and rate hikes in some cases, including in the Eurozone. We put a 30% probability on this scenario, but that may change rapidly.

Stagflation

In this scenario we’ve modelled an even larger oil price and broader supply chain shock. Non-linear oil price dynamics kick in, with limited storage capacity used up and production shutdowns not easy to reverse.

We are using a $180 average oil price over March, and a forward path that is still above $100 by year-end. Transport, chemical, fertilisers, and food production all experience a significant cost shock. Inflation spikes into the high single digits and doesn’t return to 2% for several years. This tips the global economy into recession.

Central banks are hiking rates multiple percentage points. We are currently putting a 20% probability on this scenario, which is very large given the magnitude of the shock. However, if the conflict ends in the coming weeks, this downside risk could just as quickly drop out of our distribution.

Looking away from the Middle East, Mr Diggle outlines several other upside and downside scenarios Aberdeen is considering for the quarter;

AI and capex collapse

AI-related spending collapses, tech stocks fall sharply and private credit defaults surge, triggering a US recession similar to the dotcom bust. US unemployment rises 2ppts, GDP declines 1.5% over three quarters, and sequential core inflation falls below 1%.

The Fed eases policy sharply in response to the weaker growth environment, taking interest rates well below neutral. We give this a 15% probability. Sharp-eyed readers may note this takes us above 100% that’s because we are no longer thinking of these scenarios as mutually exclusive, so they don’t need to sum to 100%.

Multiple of these shocks could play out at points over our three-year forecast horizon.

AI eats all the jobs

A new downside which takes inspiration from the recent Citrini memo, but grounds the scenario in more internally coherent economic dynamics. Rapid advances in AI mean it substitutes for a wide variety of service-sector work, raising unemployment.

Central banks are slow to react, perhaps because of a misdiagnosis that rising unemployment reflects a higher natural rate. Eventually, policy rates fall to the effective lower bound, but the economy is already in a liquidity trap.

Fiscal positions deteriorate, as income tax takes decline. Low marginal propensities to consume mean the higher incomes enjoyed by capital owners are not spent on new wants and needs that would create new employment.

US unemployment rises to 10%, GDP is contracting, and the fed funds rate is ultimately cut to zero.

We put only a 5% probability on this scenario, because of the strong economic conditions that have to hold for it to occur.

Bond market rout

Here the Warsh Fed rapidly shrinks the balance sheet, while fiscal easing in Japan and prospect of a new UK government causes market concerns. Active Fed bond sales start again, and investors become concerned that it will no longer backstop the market in future crises.

In Japan, fiscal policy is eased significantly, while moral suasion to discourage the BoJ from tightening is interpreted as politicisation. And in the UK, a shift in the fiscal strategy to allow for more deficit-financed government spending causes serious concerns about fiscal sustainability.

All of this causes a large increase in term premia, with the yield curve aggressively steepening.

We give this scenario a 10% probability because, while certain aspects of the scenario are plausible, it requires a much more dramatic shift in policy that does not itself respond to the market signal of higher yields.

Productivity boom

In this scenario US potential growth is boosted by AI and perhaps the supply-enhancing aspects of President Donald Trump’s agenda. But there is no material increase in technological unemployment.

Unit labour costs shrink, reducing inflationary pressures, and firms’ profit margins widen, encouraging further investment in AI. US potential growth rises from under 2% to more than 3%. But the lower inflationary impulse allows the Fed to cut more rapidly.

We have put a 20% probability on this scenario, as there are some early signs of AI boosting productivity, but the speed and extent of the boost would need to be much greater than currently visible in the data.

Fiscal expansion

A new scenario in which easier fiscal stances in the US, Eurozone, and Japan boost global growth and inflation, but also push up on policy interest rates and term premia.

In the US, easier fiscal policy comes from corporates receiving rebates for the IEEPA tariffs, while the administration fails to rebuild the tariff wall to the pre-IEEPA strike-down level due to opposition in Congress.

Stronger nominal US growth and labour market outcomes mean there are no Fed rate cuts this year. In Japan, Prime Minister Sanae Takaichi delivers a two year suspension of the consumption tax on food. The Bank of Japan (BoJ) hikes rates four times this year.

German fiscal easing comes online quicker than expected, and there is even higher defence spending with a greater emphasis on keeping the spending within Europe.

We give this scenario a 15% probability, in part because it requires a relatively benign market reaction to more aggressive fiscal policy.

Paul Diggle is chief economist at Aberdeen