The dawn of 2025 has barely arrived, yet there is already much consternation in the world of finance, with the policy uncertainty and the surreal geopolitical posturing emanating from the new presidential term in the US not helping, says Björn Ebert, Financial Services Leader at PwC Luxembourg.

Sluggish economic growth and persistent global conflicts have contributed to a surge in bond yields worldwide, sending a clear message about investors’ expectations.

News media increasingly use the term "chaos" to describe uncertainty and instability. However, according to Chaos Theory, chaos is not synonymous with disorder. It refers to a complex system—one that, despite its complexity, is still governed by underlying patterns and can be analysed.

In fact, at least since the resurgence of double-digit inflation and inter-state warfare on the European continent three years ago, business leaders now consider geopolitical tensions to be one of the primary threats to economic growth, as regional conflicts and shifts in international trade have increased significantly in recent years, challenging the resilience and strategies of multinational corporations.

The same volatile dynamics are unfolding globally — political tensions rising across Europe and persistent unrest in the Middle East. This growing instability makes it increasingly vital for asset managers and investors to factor geopolitical risks into their strategies as a systematic consideration.

The Old Continent

In its latest Financial Stability Review, the European Central Bank (ECB) identified elevated risks to financial stability, driven by a volatile macro-financial environment. While inflation in the euro area has moved closer to the 2% target, the economic outlook remains fragile, with downside risks to growth.

The two largest economies in Europe (40% of EU’s GDP), France and Germany, are confronting significant political and economic challenges. In France, rising borrowing costs have intensified the need for fiscal restraint, while Germany is dealing with growing competition from China and the potential for trade conflicts with the US.

Fiscal challenges in the rest of the euro area add to the complexity of the situation. While debt-to-GDP ratios have improved since the pandemic, high debt levels and rising costs for servicing that debt remain concerning. The expected increase in borrowing costs, as older debt is refinanced at higher interest rates, raises doubts about the sustainability of sovereign debt, especially in EU countries with large deficits and low growth potential.

Some experts believe that the economic challenges stemming from the ongoing conflict in Ukraine are contributing to the rise of right-wing parties all over the continent. What emerges is a euro area that no longer provides the stability it once did for investors, presenting instead a complex mix of elevated risks and subdued returns.

There are various proposed solutions to address these challenges. JP Morgan anticipates interest rate cuts, while Mario Draghi’s report advocates for maintaining a balance between innovation and regulations. Some even advocate for an outright abandonment of the euro. Regardless of the approach taken, investors and asset managers should keep a keen eye on such developments, particularly given that business and consumer confidence across Europe continues to erode.

The Eastern Question

Ongoing geopolitical tensions in the Middle East have significant economic implications for the global economy, and a stark reminder of this came in the fall of 2024 when long-range missiles launched by Israel against Iran caused a spike in oil prices. This caught many investors off guard, as market consensus at the time expected prices to decline, leading to widespread short positions in oil. However, escalating conflicts in the Middle East and Trump’s re-election reversed these expectations, causing a sharp price surge and breaking the short positions.

According to Economics Observatory, geopolitical tensions in the Middle East could lead to oil production and supply chains getting increasingly disrupted, driving up energy prices. In turn, this could lead to higher inflation, reduced global trade, and slower economic growth, particularly in countries with strong trade ties to the region. Moreover, the added pressures of rising energy costs and shipping disruptions could further strain businesses and consumers, impacting confidence and investment. If the flareup in the region continues to escalate, these factors, along with possible refugee crises and increased defence spending, could result in long-term sluggish growth worldwide.

Echoes of the Jazz Age

Many asset managers refer to current times as the “Roaring 20s”, given unrestrained American economic growth rates and epoch-defining technological innovation, echoing the immediate post-First World War era of quasi-irrational exuberance. As F. Scott Fitzgerald wrote, “It was an age of miracles, it was an age of art, it was an age of excess and it was an age of satire.”

However, it is critical to recall that the 1920s also harboured significant economic imbalances, wholly unregulated financial markets, and growing political tensions, setting the stage for the dramatic Wall Street crash of October 1929, the Great Depression, and the eventual rise of authoritarian regimes and global instability.

To a certain extent, parallels can be drawn between then and now. We live in a world riddled with uncertainties: geopolitical tensions, armed conflicts, and shifting alliances dominate the headlines. Simultaneously, we are amidst a transformative AI revolution that promises to redefine industries and economies alike. Thanks to this duality of opportunity and risk, asset managers and investors, much like in the past, find themselves at the intersection of hope for sustained growth and fear of the unknown.

Navigating this era requires a balanced perspective that embraces uncertainty as a constant. Investors must recognise that risks and opportunities often stem from the same root: change. By integrating comprehensive risk frameworks, fostering adaptive strategies, and maintaining a long-term vision, it is possible to thrive in a world defined by flux. The future, much like the past, will reward those who remain vigilant, informed, and prepared to act decisively in the face of evolving realities.

By Björn Ebert, Financial Services Leader at PwC Luxembourg