1. Geopolitical risk forecasts for Europe (by Sakari Linden).

2. U.S. inflation exploded in March.

3. A near-worst-case scenario for U.S. inflation.

This week we’ll concentrate on U.S. inflation and provide you with a “near-worst-case” scenario for it, which at the time of writing looks scarily likely. However, we begin with a geopolitical risk forecast of Europe by Sakari Linden.

Sakari is a Belgium-based geopolitical analyst who is a former political advisor in the European Parliament. He outlines the worrying trajectory Europe is on, concerning the stance of European leaders towards Russia. He argues that, at the current trajectory, a war between Europe and Russia looks inevitable. Moreover, he argues that, again, at its current trajectory, the war would erupt between this year and 2028.

Then we move into U.S. inflation. There was something of an explosion in the U.S. Consumer Price Index (CPI) in March. It was actually so big that even our supply chain collapse scenario was unable to capture it fully.

The “error” in our previous scenario forecasts for U.S. inflation was that we did not combine the oil crisis with the supply chain collapse. We also did not correctly model the severity of the current shock. In this report, we set out to fix these issues.

Our modeling implies that in the case of an extended closure of the Strait of Hormuz and the “hot war” restarting and continuing for a few more weeks, U.S. inflation would reach double digits by September. At the end of the forecasting period (March 2027), U.S. inflation would break a record with a 17% annual change in the CPI.

Tuomas

Geopolitical Risk Forecast: Europe slides towards a continental war

By Sakari Linden

Ukraine has been in crisis since February 2014. The conflict escalated after Russia invaded Ukraine on February 24, 2022, after Ukraine’s armed forces started a massive attack against rebels of two Russian-speaking regions of Ukraine, Donetsk and Lugansk, from February 16, 2022, onwards. Currently, in April 2026, Russian troops occupy about 20% of Ukraine.

Geopolitics can be used in order to explain past events and to forecast future developments. Both the western powers and Russia have good reasons not to give up their grip on Ukraine. On the one hand, Anglo-American theories of Eurasian geopolitics put emphasis on the containment of Russia, the primordial interest of the US to stop a coalition between Germany and Russia, and the goal to isolate Russia from Eastern Europe.

On the other hand, the Northern European Plain was historically used by European powers to conquer Russia. This historical fact has affected deeply Russian way of thinking of its security. It also explains Russia’s determination to act in its western neighborhood.

Russian leaders have set their hopes in the “Spirit of Alaska” i.e. potential for US-Russian rapprochement after presidents Trump and Putin met each other on August 15, 2025 in Anchorage, Alaska. Unfortunately, historical patterns and current geopolitical dynamics do not favor a peaceful solution to the conflict.

The problem from the point of view of the “Spirit of Alaska” is that the question is not only about Ukraine. There is a much bigger battle going on at the world level between the unipolar world model based on the hegemony of the United States, on the one hand, and the emerging multipolar world model promoted mainly by China and Russia, on the other. The US has started to defend aggressively its hegemony against its challengers by launching wars in Venezuela and Iran and targeting China and Russia’s maritime energy routes.

The status quo does not satisfy anyone on the battlefield. The EU cannot admit a defeat in the war that has already become one of its own. The defeat would result in the EU losing face and authority in front of its member states, which would release the centrifugal forces of the EU system and thus start the break-up process of the EU. Russia, for its part, is seeking better protected borders against the western threat, which the current frontline does not provide. Russia has an incentive to reach for the Dnieper River and eventually for Odessa, which would enable Russia to cut Ukraine off from the Black Sea coastline.

While it is true that the US does not have sufficient resources to wage war in all three global theaters of war, in Europe, the Middle East, and East Asia, anymore, it does not mean that the US would be willing to decrease the level of pressure against Russia. In the new burden-sharing model between the US and the EU, the EU invests significantly in its military capabilities, but in a way that implements the geopolitical goals of the United States. The EU’s role in this new equation is to exert military, economic, and political pressure on Russia and to strive to bring Ukraine into the sphere of influence of the Collective West.

The presence of continued pressure can be seen in Ukraine too. Rather than finding a peaceful solution to the conflict, the Western powers have preferred escalation in Ukraine. Examples of escalation on the Western powers’ part are Ukraine’s Western-backed drone attacks against Russia’s strategic bombers in June 2025, as well as against President Putin’s residence in December 2025.

Recently, Ukraine has used airspaces of the Baltic States to attack Russian targets. The UK is also threatening to start to seize Russian ships at the seas. These are the most potential ways that could escalate the conflict and expand it into a continental war between the EU and Russia.

Moreover, the recent victory of the Tisza party in the Hungarian elections will likely remove obstacles from EU’s further financial support to Ukraine, as well as from Ukraine’s EU membership, which could escalate the war in Ukraine.

Ukraine is at the center of great power interests to such an extent that restoration of peace seems highly unlikely. The US fights for its superpower status, and the EU needs outside enemies in order to preserve its unity, to avoid break-up, and to further its common defense plans. Therefore, a direct war between Russia and the EU looks to become inevitable between 2026 and 2028.

U.S. inflation goes “there”

We saw a massive month-over-month jump in the U.S. Consumer Price Index in March. Figure 1 depicts this 0.9% jump and March figures of core inflation and super-core inflation alongside our oil crisis scenario forecasts.

We can safely assert that our modeling structure, assuming just a repetition of the 1970s oil crisis, failed to account for the severity of the current shock. To our defense, the massive 0.9% MoM jump in the CPI did fit within the 95% confidence intervals of our oil shock scenario forecasts (just barely).

We get much closer of the realized figure of the CPI, when we compare it to our supply chain collapse scenario. Even that scenario was not fully able to account for the massive jump, though, while in this scenario the actualized is safely within the 95% confidence intervals (the point estimate of our scenario forecast for March CPI MoM change was 0.55%).

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1. Developments in lending to the Private Credit.

2. Forecasts for U.S. business lending and lending to NDFIs.

This week we concentrate on Private Credit. Yesterday, I published an entry that detailed the “hidden” explosive growth of loans to the non-depository financial institutions, which consist mostly of credit funds and other “creatures” of the private credit sector. I actually came across the data while I was writing this.

What we uncover here are notably developments occurring in the lending of U.S. banks. We consider them to be symptoms of an ongoing bailout of the private credit sector by major U.S. banks.

Our forecasts present two paths ahead for U.S. bank lending. The other is more lenient, while the other presents a shock approaching the sector, which could lead to tighter lending standards and increased risk for borrowers. At this point, we cannot fully assess which is more reliable. The “shock model” has better statistical properties, but the scenario it paints is extreme.

Patricia will take a break from writing to us this week, while I report our recent email discussion later today. Another geopolitical expert will soon join us to write semi-regularly. I will introduce him when his first piece is published.

Have a great weekend!

Tuomas

Are there signs of cracks in lending to the U.S. private credit sector?

We start our analysis by assessing the recent developments in lending of U.S. commercial banks. They show clear developments or changes from our last comprehensive look at the sector at the end of November. Let’s begin by assessing the development of lending to non-depository institutions by U.S. commercial banks.1

Lending by U.S. commercial banks to the NDFI’s has continued unabated since our last check in November. There has been a smallish slowing down in the lending activity during the recent weeks, but nothing drastic. However, business loans issued by U.S. banks reveal a very interesting recent development.

From late January on, the business lending activity of U.S. banks saw a massive increase in the magnitude we have not seen since June 2022 (when U.S. inflation peaked).2 This is interesting and could be speculated to indicate a notable pickup in business activity of U.S. companies. However, the devil is in the details also on this one. Figure 3 presents the split of business lending between large and small U.S. commercial banks.

Figure 3 shows that most of the growth in business lending has come from large U.S. banks, while the growth of the business lending of smaller banks has remained steady. If we were to expect a notable pick-up in U.S. business activity, we should see the business lending of smaller banks increase because they fund especially the local small- and mid-sized companies, SMEs, which are the backbone of the U.S. economy. We are not seeing this. So, what is going on?

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1. The divergence in OECD’s leading indicators between China and the rest of the word keeps on growing.

2. Two oil crisis scenario forecasts paint an abysmal picture for the global economy going forward.

Essentially everyone (“and his uncle”) is trying to assess the effect of the closure of the Strait of Hormuz and the destruction of oil and gas infrastructure in the Middle East. Analysts’ estimates range from “apocalypse is coming” to “the president got this under control.” Like we have noted several times, the latter of these is most likely to be badly misguided, while we’ve been cautiously leaning towards the former. Cautiously, because there’s a clock with this war. The longer it lasts, the worse the economic hit will be.

This Easter week, we continue to assess the effect statistically. Two weeks ago, we assessed the effect on the U.S. economy. Here we analyze the effect of the emerging energy crisis on the global business cycle with the help of the OECD’s leading indicators and statistical scenario modeling.

Our forecasts imply a drop in the global economic activity rivaling that of the Global Financial Crisis approaching. Before moving into the actual scenario forecasts, we update the recent developments in OECD’s leading indicators.

Tuomas

The divergence diverges, again

The divergence in OECD’s leading indicators between China and the “rest” kept on widening in February. The business cycles in Japan, four major European nations, the G-20 countries, and the U.S. have now headed in opposite directions from that of China for about a year.1

The months, when this divergence from the business cycle of China started, are as follows:

• January-February 2025 with four major European nations;

• May 2025 with Japan;

• June 2025 with the U.S. and the G-20.

We have speculated on the source of this divergence several times (see, e.g., this) and will not continue with that here. Our updated forecasts (not reported) indicate a faster convergence of the business cycles of China and the G-20 than our previous forecasts from February. However, it is unlikely that the model is capable of seeing the oil and likely supply chain shocks that are currently approaching. For this, we need scenario analysis and forecasting.

The effect of an oil shock to the global business cycle

What we are going to do next is to build two scenarios to model the effect of the oil or energy shock to the global business cycle. Like previously, we use the information from 1970s oil shock for our scenarios. In other words, we harvest information on the effect of the 1970s oil shock on OECD’s leading indicators to forecast their behavior in the shock that is now emerging.

Some of you may question the plausibility of this approach. That is, some may wonder how information from 50 years ago would help us understand what’s going to come next. This is where the “magic” of statistical models and statistical information comes into play.

The statistical model we are using (VAR) assimilates both the information from the effect of the oil shock in the 1970s and the development of the leading indicators since. It does not just mechanically add the information from the 1970s into now but brings the information forth into the model and thus “today” through the dummy-variables.2 The dummies store the effect of the 1970s crisis, and the model mirrors the information they hold against the most up-to-date information (data) to construct the forecasts.

The problem we have with the OECD data is that not all the country series of leading indicators reach the beginning of the 1970s. This forces us to exclude China from our analysis, because its data reaches only the early 1990s.

To keep the model simple, we concentrate on assessing the effect using three leading indicators: Japan, the G-20, and the U.S. We include them with the assumption that the “Japanese miracle” and the U.S. as the leading economy of the world before the GFC were the main drivers of the global business cycle approximated by the leading indicator of the G-20 in the 1970s.3

Figure 3 presents the leading indicators of the two countries and the G-20. We mark October 1973 as the starting month of the first oil crisis following the onset of the Yom Kippur War and the oil embargo in that month. We link the end of the crisis to the official end of the U.S. recession in March 1975. The effects of the oil crisis, naturally, continued beyond March 1975, but we believe that this period contains the most relevant information for our analysis of the economic impact. We can also see from the the figure below that the world economy had already started to slow down before the oil embargo hit. However, we consider this to have been a part of normal business cycle fluctuation (and not, e.g., due to expectations of the war approaching) and thus exclude it from our analysis.

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1. Grand (Unified) Geopolitical Theory in the Middle East.

2. After 26 days of war, most of Iranian military arsenal is still intact (by Patricia Marins).

3. The Iranian play altering the Eurasian “chessboard.”

We are approaching a crucial turning point in the war in the Middle East. First President Trump issued and then backed out of his 48-hour deadline based on good news on “negotiations” that never happened. Now, we are running with another deadline, which ends on Saturday. In the worst case, this deadline will mark the beginning of a new Vietnam War with dire consequences for the world.

This week, we’ll provide you with information on both the larger play behind the conflict in the Middle East and updated information on the capabilities of Iran. We start with the extension of my Grand (Unified) Geopolitical Theory to the Middle East. It shows how President Trump’s administration is failing in a crucial long-term play for the U.S. I assert this to occur only due to the incompetence of his administration.

In the second piece, Patricia will detail and update the military capabilities of Iran. Her analysis shows that any ground assault by the U.S. is likely to not just fail but to lead to a high number of casualties, especially on the U.S. side.

We end with a notion of how the war against Iran is altering the global geopolitical “chess board.” What we are currently watching can very well turn out to be the end of U.S. military and financial hegemony, like we noted last week. This is also the main reason why the war is likely to continue for some time still; empires never go down quietly nor peacefully. We end our report with some hedging recommendations.

We are also extremely glad to announce that Patricia has agreed to become our weekly contributor :). Her insightfulness will provide critical information on the rapidly changing geopolitical landscape.

Tuomas

Implications of the Grand (Unified) Geopolitical Theory for the Middle East

In January we introduced the Grand (Unified) Geopolitical Theory Tuomas has been gradually constructing since his revelation about the Russo-Ukrainian War in September 2022. The main building block of the theory has been the observation that it was the superpower-structure, in other words, the battle between the U.S. (NATO) and the Soviet Union (Warsaw Pact) that fostered the long period of calm in Europe. When it ended, we entered into the period of never-ending wars run by the U.S. military machine.

The collapse of the Soviet Union led to the failing of the superpower-structure, which had dominated the world since the Second World War. Many still consider that the creation of the supranational-structure, enshrined in the supranational entities, like the United Nations and the International Monetary Fund, was behind the long period without major wars in Europe and relative calm elsewhere. However, recent developments reveal that it was actually the superpower-structure that enforced the period of (relative) peace and prosperity in Europe and the ability of the supranational structure to function (somewhat) properly in the world. The failure of the one superpower, the Soviet Union, caused the ambitions of the other superpower (the U.S.) to be unleashed, leading us to the current predicament.

The breaking of this proverbial military “stalemate” created a condition for ever-increasing U.S. influence in the world. At first it seemed like liberty, but the reality turned out as something very different. Wars started to appear across the Western hemisphere, including, for example, the first Gulf War (1991); the first Chechen War (1994-1996); NATO’s (terror) bombing campaign of Serbia in 1999; the Global War on Terrorism, launched after the September 11 (2001) terrorist attacks; and, finally, the still ongoing Russo-Ukrainian War, launched on February 24, 2022 (or 17?), and war against Iran. Taking them separately, the wars could be viewed by some as wars of “freedom” or “security,” but with a high likelihood, all the wars since the collapse of the USSR are just pieces in the (grand) geopolitical chessboard. Let us now elaborate on this in more depth.

Dr. Zbigniew Brzezinski, a highly influential political scientist who served as National Security Advisor during Jimmy Carter’s presidency, envisioned a roadmap for U.S. global dominance after the fall of the Soviet Union. His “grand plan” was published in his magnum opus: The Grand Chessboard: American Primacy and Its Geostrategic Imperatives, in 1997. One passage from the book basically laid out the plan in Europe, which we outlined in January. It also links Europe to the “fate” of the Middle East.

It follows that a wider Europe and an enlarged NATO will serve well both the short-term and the longer-term goals of U.S. policy. A larger Europe will expand the range of American influence-- and, through the admission of new Central European members, also increase in the European councils the number of states with a pro-American proclivity-- without simultaneously creating a Europe politically so integrated that it could soon challenge the United States on geopolitical matters of high importance to America elsewhere, particularly in the Middle East.

What are these “geopolitical matters of high importance” to the U.S. in the Middle East? Dr. Brzezinski details them as the following:

Eurasia is the globe’s largest continent and is geopolitically axial. A power that dominates Eurasia would control two of the world’s three most advanced and economically productive regions. A mere glance at the map also suggests that control over Eurasia would almost automatically entail Africa’s subordination, rendering the Western Hemisphere and Oceania geopolitically peripheral to the world’s central continent.

This is to say that to control Eurasia, with its vast mineral, economic, and population resources, is to control the world. The map does not lie.

After the fall of the Soviet Union, Dr. Brzezinski asserted the U.S. leadership should concentrate its power to control this landmass:

This huge, oddly shaped Eurasian chess board -- extending from Lisbon to Vladivostok -- provides the setting for “the game.” If the middle space can be drawn increasingly into the expanding orbit of the West (where America preponderates), if the southern region is not subjected to domination by a single player, and if the East is not unified in a manner that prompts the expulsion of America from its offshore bases, America can then be said to prevail.

With the “middle space,” he means Europe, with the “southern region” he refers to the Middle East, and with “East” he refers to China and her neighboring countries, including Russia, as her landmass essentially covers the width of the “chessboard.” These were the developments Dr. Brzezinski noted the U.S. should work against.

But if the middle space rebuffs the West, becomes an assertive single entity, and either gains control over the South or forms an alliance with the major Eastern actor, then America’s primacy in Eurasia shrinks dramatically. The same would be the case if the two major Eastern players were somehow to unite.

Finally, any ejection of America by its Western partners from its perch on the western periphery would automatically spell the end of America’s participation in the game on the Eurasian chessboard, even though that would probably also mean the eventual subordination of the western extremity to a revived player occupying the middle space.

All the actions after the fall of the Soviet Union up until the current war against Iran can be seen as, more or less, calculated actions to establish the U.S. hegemony over Eurasia (and thus the world) following the advice of Dr. Brzezinski. Like explained in the first part of the Grand (Unified) Geopolitical Theory, the EU and especially the war in Ukraine were, most likely, “moves” to establish full control of the Middle (Europe). The main aim, as somewhat covertly recommended by Zbigniew, was to destroy the power of France and Germany to exert their influence over Europe and North Africa. In other words, to “neuter” them through the EU. Considering the speed Europe has sunk itself in the wake of the onset of the Russo-Ukrainian war, we can consider these resounding successes from Washington, until now.

The process the administration of President Trump has put in motion with Iran, which we detail below, goes completely against the advice of Dr. Brzezinski. This is probably because of the hubris that seems to have taken over the Trump administration as well as Israeli, neocon, Zionist, and even Evangelical factions affecting it.

Iran is currently altering the ‘chessboard’ and emerging as something much more than just a “geopolitical pivot,” like she was labeled by Dr. Brzezinski.1 We can expect even more, because Iran still has major firepower in store.

Iran: 26 Days of War and a Still Largely Operational Arsenal

By Patricia Marins

After almost one month of war, Iran’s military arsenal remains largely operational across air, land, and sea domains. This stands in stark contrast with the narrative touted by the White House.

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1. The U.S. inflation picture in February.

2. Forecasts for U.S. inflation assuming no oil shock scenario.

3. Forecasts for U.S. inflation under an oil shock and supply chain collapse.

The war in the Middle East rages on. Patricia published an excellent analysis on the worrying trajectory of the conflict yesterday. If you have not, I urge you to check it out. It is free to read.

This week, we’ll continue to assess the economic effects of the war, concentrating on the U.S. Most of the effects arise from the closure of the Strait of Hormuz. Writing about it now is even a bit surreal considering that I warned of the (dire) economic effects of the closure already in October of 2023. The interesting recent twist in it is that “Petroyuan” can break the closure relatively soon, as it looks like Iran allows passage to ships that stay away from the conflict and buy their oil with Renminbi. This, i.e., the beginning of an end of the petrodollar, is essentially what we speculated would occur last week.

Another positive development is that rumors of serious infighting within the Trump administration have started to appear. According to them, Vice President James David Vance would be strongly opposing the continuation (and deepening) of the war. My current thinking is that we could see an end to the conflict by the end of April. Let’s see (I’ll detail them later).

Regardless, an economic shock is already on its way and the only question is, how bad will it get? Reports of high prices at the pump in the U.S. and even fuel shortages emerging in Asia have started to emerge. The path of inflation is dictated by heavy uncertainty.

We will provide a path through the uncertainty with the help of two scenario forecasts detailing the possible paths of U.S. inflation for the next 12 months. We start with standard forecasts, which include no specific information on the approaching shock. These forecasts act only as a benchmark, as the shock is already emerging, and it will get worse, even if the war ends tomorrow. The more serious scenarios encompass an oil (energy) shock and disruption of global supply chains. Naturally, the latter of these paints a very detrimental path for the U.S. economy going forward. Our assessment is that, if the war continues, we will start to move into the supply-chain collapse scenario after next week.

Tuomas

The state of U.S. inflation

Let’s first check how our inflation forecasts from the past month fared. In February, the Consumer Price Index (all items, all urban consumers, U.S. city average, seasonally adjusted), or CPI, rose by 2.4% annualized, 0.3% month-over-month (MoM). The core inflation rose by 2.5% annualized and 0.2% MoM. The “super-core,” i.e., services less energy costs, rose by 2.9% annualized, 0.3% MoM.

Our forecasts, from 17 February, indicated that the CPI would increase, month-over-month, by 0.3%, the core inflation by 0.4%, and the super-core by 0.3% in February. In other words, our forecasts accurately predicted the rate of change of CPI and supercore inflation, but they failed to foresee the deceleration of core inflation. Every realized figure was within the 95% confidence intervals, though. Figure 1 presents our February forecasts and the realized value for the MoM change in core inflation with 95% confidence intervals.

Given the accuracy of our forecasts for the CPI and super-core inflation, it’s plausible that the deviation from the core is merely a random statistical event. What this means to say is that no forecast can be assumed to be 100% accurate, but there’s a stochastic variation in the forecasts based on the assumption of the underlying probability distribution. All statistical forecasts are of the form: estimate +/- the margin of error, where the “estimate“ or “point estimate” is the term for the actual forecasted value and the margin of error is the assessment of the model on the fluctuation of the forecast based on the underlying distribution and the predetermined threshold. In economic sciences, 95% is generally used as a threshold for “statistically significant” observation (and forecast), while, for example, in physics, much tighter thresholds, like 99.999%, are oftentimes used. This difference arises from the fact that stochasticity (randomness of observations) in measured physical phenomena is generally much smaller than in economics. Just think of it as a difference between the actions of men vs. laws of physics. Thus, at this point we do not make any major changes to our forecasting model, because the miss in our core inflation forecast can be just random statistical variation.

But where is U.S. inflation heading? Figure 2 presents the recent monthly changes in the three key inflation metrics.

What we have seen, since the shock the onset of the war in Ukraine created in 2022 started to ease about a year ago, is a stabilization after a relatively long period of heavy fluctuation. The problem is that this is about to change abruptly due to the shock arriving from the Middle East. We do not know its length and depth, though, because it is determined by political decisions of leaders concerning the Gulf region and their impacts on global markets. We naturally specialize in addressing such uncertainty through scenario forecasting. Let’s first provide the “baseline” by updating our standard inflation forecasts.

Forecasts for U.S. inflation in the no-oil-shock scenario

We extend the forecasting model from February to also include the (monthly) supercore inflation, following the update (and correction) made by Tuomas. This modification diminished the mean squared errors of the model somewhat, which implies that the super-core is providing information that is helpful in modeling and forecasting the system of three variables: CPI, core inflation, and supercore inflation. Otherwise, we use the same setup as in February.

We approximate the monthly U.S. CPI, core inflation, and super-core inflation series with a stochastic trend process. That is, we assume, based on the results of the Augmented Dickey-Fuller (ADF) test indicating that the series contain unit roots, that the series are driven by stochastic trends. The Johansen Trace Test with updated data indicates that two stationary cointegration vectors would exist between the three variables (using a 5% level of statistical significance). We then applied the Vector Error Correction (VECM) to estimate the model and forecast the path of the three inflation measures for the next 12 months.1 Figure 3 presents the forecasts it yielded.2

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1. Towards the collapse of the petrodollar trade.

2. Statistical scenario modeling of the effects of the shock of the closure of the Strait of Hormuz for the U.S. economy.

3. The economic worst-case scenario for the U.S. economy.

What naturally interests us all is how the economic shock that has started to emerge will be. In this Special Issue, we present both statistical and economic (theoretical) modeling to answer this question, concentrating on the U.S. economy.

What many fail to grasp is that the road we’re on implies the collapse of the U.S. financial and military hegemony. I understand that this is too far for many to grasp at this point, but I already explained some of it in my update to the Sword of Damocles and yesterday. We now want to open it up a bit more.

We also want to add some (statistical) “meat on the bones” on the shock that’s about to hit the world economy. We start the modeling of this shock, naturally, from the U.S., which is the biggest economy and holder of the global reserve currency. We construct a model based on our forecasting model for the U.S. GDP to model two scenarios: an oil shock and a supply chain shock. Naturally these two yield rather different outcomes, with the latter presenting something of an “apocalyptic” near-term trajectory for the U.S. economy.

We end with a worst-case scenario for the U.S. economy, which underlines the dire toll the war can take on the U.S. We are in the midst of major geopolitical and economic upheavals.

Tuomas

Towards the end of the petrodollar?

A major change slowly manifesting in the Middle East is the possible (likely) end of the petrodollar trade. U.S. dollars rose to dominate oil transactions after the collapse of the Bretton Woods system in 1974, when Saudi Arabia and the U.S. reached an agreement where the oil from the Saudis would be priced and sold in U.S. dollars. In return, the U.S. promised to provide security guarantees and access to American financial markets for the Kingdom of Saudi Arabia. Other countries of the OPEC (the Organization of the Petroleum Exporting Countries) quickly followed suit. Notably, the petrodollar is not based on any formally binding agreement, but it is more of a convention, based on mutual benefit.

In the Bretton Woods system, created in 1944, countries tied the value of their currencies to the USD, whose value was tied to gold. It created an exceptional role for the USD because it made it a global reserve currency. At its peak, some 120 countries were included in the system, which created a vast pool of demand for U.S. dollar liquidity, with the USD effectively backing up the global financial system.

When the Bretton Woods system collapsed due to the excess money creation to fund the war in Vietnam, another source of (global) demand for the USD needed to be created to absorb the money printing (credit creation) of the U.S. The petrodollar was erected to fulfill this need. The petrodollar system effectively became the source of the forever-wars of the U.S., because keeping it alive meant keeping U.S. ‘boots on the ground’ globally. To fund all the military bases, the U.S. needed to create a lot of credit (money). So, essentially, there was a never-ending loop, where the war machine required money to feed the global demand for the USD to provide the security to guarantee the reserve currency status of the U.S. dollar. Effectively: money for safety for money. Rinse and repeat.

Now, the question becomes, what will happen to the petrodollar system if the U.S. is forced to retreat from the Middle East? This is how Grok-4 answered this question (at noon on 10 October 2026):

Over time, the absence of U.S. forces could catalyze a paradigm shift, aligning with “petrodollar war theory” arguments that U.S. interventions have historically enforced dollar primacy.

Without boots on the ground, the system might unravel as follows:

• Geopolitical Realignment: Gulf nations could pivot toward China, Russia, or BRICS for security and economic partnerships, accelerating yuan-based oil deals and diminishing U.S. leverage over global energy flows. This mirrors recent sentiments where Saudi officials accused the U.S. of abandonment, potentially ending long-standing petrodollar pacts.

• Erosion of Dollar Reserve Status: A decline in petrodollar demand could force the U.S. to balance trade deficits more stringently, leading to austerity measures, reduced military spending abroad, and a vicious cycle of weakened global influence. At the extreme, this might result in higher U.S. inflation and borrowing costs, as foreign holdings of dollar assets drop.

• Counterarguments and Resilience: Not all views predict collapse; the dollar’s liquidity and institutional advantages could sustain it even without full military backing. A phased withdrawal with contingency plans might mitigate blowback, preserving some alliances and limiting immediate disruptions to oil trade.

Overall, while not an overnight death knell, a U.S. exit would likely hasten the petrodollar’s decline, reshaping global finance toward a more fragmented, multi-currency energy market and curbing American economic exceptionalism.

To fully address the effect, we need to emphasize the change occurring in the foundation of the petrodollar, i.e., security guarantees. Iran is currently completely demolishing these in the Middle East. While the liquidity provided by the USD would still be there (for a while longer at least) after the U.S. withdrawal from the Gulf, this would not weigh much standing against safe passage through the Strait of Hormuz. Iran has already asserted a policy line that it will control the Strait also in the future. If so, it could set the condition that all vessels using the Strait need to use Rial in their transactions. So many companies use and depend on access to the Strait that they would be forced to agree. Thus, if Iran wins this war and takes full control of the Strait, it will almost immediately rise as a major regional player pushing the U.S. out. This would, most likely, deliver a mortal blow to the petrodollar and the global U.S. hegemony.

The fall of an empire is never quick nor pretty. This is what we’re seeing to play out in the Gulf. Israeli PM Benjamin Netanyahu lured the U.S. into a battle it could very well lose, without the U.S. president Donald Trump probably understanding what would be at stake if their decapitation strikes and “revolution” would fail. This is exactly what has now occurred.

Yesterday, Tuomas presented a scenario on how the war would end, arising from market reactions. Here we just add that ending the war can come only through the capitulation of Israel and the U.S. If the U.S. capitulates and withdraws from the Middle East, it would deliver a blow that could turn lethal for the petrodollar and thus for the U.S. global hegemony. That said, Iranians are enraged, and the “blood vengeance” from the killing of Khamenei has united both religious and secular factions of Iranian society. We don’t think there can be a victory against such a nation, which has prepared for this conflict for decades.

So, we consider that economic repercussions are what will end this conflict. The problem with this is that, when they appear, there will be no quick fix to them. This implies that if the war does not end within the next seven days (or so), we need to start to expect a global economic depression.

How bad of an economic shock?

Statistical modeling is a good tool for analyzing different economy-wide scenarios if there are (more or less) matching scenarios to be found in recent history. More precisely, we can construct a statistical forecast on the effects of shocks if shocks of a similar kind can be found from a period when an economic variable under interest, like gross domestic product, has been measured. When we consider the effects of the closure of the Strait of Hormuz, from henceforth “the Strait,” two historical examples come to mind: the 1973-74 oil crisis and the first global Covid lockdown in the spring of 2020.

In early October 1973, the Yom Kippur War broke out between Israel and the coalition of Arab states led by Egypt and Syria. On October 19, President Richard Nixon requested a $2.2 billion emergency loan to Israel from U.S. Congress. Immediately after this, the Organization of Arab Petroleum Exporting Countries proclaimed an oil embargo against the U.S. and all Western countries supporting Israel. In six months, the price of oil rose by nearly 300% and even more in the U.S., which at that time was highly dependent on Middle Eastern oil.

In January 2020, the Covid-19 virus emerged from Wuhan, China. By the end of March, the whole world was in a lockdown (in the U.S., the lockdown started on 15 March). The economic hit was massive with the service sector shut down and financial markets collapsing (up to a point of a bailout by the Federal Reserve), while supply chains broke down. While it lasted for just a few months (basically for one quarter, Q2 2022), it is the closest historical example of the rupturing of global supply chains.

What we are going to do is to harvest information from these two drastic occurrences to build two statistical scenarios on the likely effects of the closing of the Strait. In the first, which we call the Oil crisis scenario, we extract data from the U.S. real gross domestic product (GDP) from quarters that saw the biggest declines between 1973 and 1975.1 They are used to statistically model a scenario where the closing of the Strait lasts a maximum of three weeks (the week starting on the 23rd).2 The foundation of this scenario is the view held by several analysts that until (approx.) the third week of the closure, resuming oil, gas, and commodities production will be relatively rapid (lasting from weeks to months). However, if the closure prolongs to a month, the shutdowns become semi-permanent, while the production of all kinds of oil-linked minerals, gas, fertilizers, and commodities will also start to shut down. This is what we warned about last week. We call this the Supply chain collapse scenario, and we harvest information from the second quarter of 2020 to model it.

To summarize, in the Oil crisis scenario, we expect the world to be hit by a severe raw energy shock (which is already on its way). In the Supply chain collapse scenario, we expect the global supply chains to begin to collapse, causing widespread shutdowns of industries and services (this is currently approaching).

We use our updated forecasting model for the U.S. gross domestic product (GDP) we unveiled last week as a basis for our estimations. We use the exact same setup, i.e., a vector error correction (VECM) model with three explanatory variables: U.S. Real Gross Private Domestic Investment (RGPDI), (seasonally adjusted) Real Gross Domestic Product (RGDP), and Loans and Leases in bank credit.3 As explained above, in the first model, we include a dummy variable that accounts for the quarters between 1973 and 1975,4 when the U.S. economy received the worst hits from the oil shock. Figure 1 presents the results of our forecasting model for this scenario.

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1. Round-up of the updated U.S. GDP forecasts with the simplified model.

2. Forecasts for GDP, including bank lending, indicate a collapse of the U.S. economy commencing shortly, followed by a strong recovery.

We will concentrate on our U.S. economic forecasts in this week’s Weekly Forecasts in two separate reports. In the first, we go through our recent forecasts for the U.S. gross domestic product (GDP) and update the forecasting model with banking lending data on U.S. commercial banks. There are reasonable grounds to assume that lending by banks would add information beneficial to forecasting the path of GDP development. This is simply because most money creation, in any economy, occurs through commercial banks.

And they do. Adding the loans and leases in bank credit series into the forecasting model leads to a notable decline in the mean squared errors of the model. This implies that adding bank lending makes the model more precise and more accurate in explaining the changes in the real GDP. This straightforwardly implies that the forecasts generated by the model would also be more accurate.

The updated forecast keeps on indicating that the U.S. economy would see something of a collapse during the next two quarters. However, it also indicates that a strong recovery would follow, which is of course questionable now.

We also extend the model to take into account the economic shock the Gulf War 2.0 can deliver to the U.S. economy. This Special Issue will be published as soon as the modeling is complete, but no later than next week.

Tuomas

GDP growth forecasts for the U.S.

Let’s start by assessing the updated forecasts of our simple model run by Tuomas during the weekend before the previous one. The forecasts indicate that the U.S. economy is expected to enter a slump, followed by a weak recovery, then stagnation, and ultimately another collapse. Figure 1 presents the forecasts.

The consistency of the forecasts is what takes our attention and increases our trust in them. Essentially, while the acceleration of the U.S. economy predicted by the forecasting model has diminished notably with data updates, all four forecasts with updated data have continued to indicate that the U.S. economy will experience something of a collapse during Q2 and Q3 this year.

This consistency of predicting “doom and gloom” for the U.S. economy is baffling, in a statistical sense. It is in the nature of statistical forecasts to change, sometimes drastically, with new data. Yet, our model has continued to show the Q2-Q3 collapse, update after update and revision after revision. Figure 3 turns the forecasts into actual (quarter-to-quarter) GDP growth numbers, which continue to be “nonstandardized” implying they are likely to be too large.

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We have to cancel the publication of this week’s Weekly Forecasts. I needed to take a break due to prolonged flu, which I did not choose to heal from (rest) earlier. During the weekend, it started to “act out,” which warned me that a rest was needed. Mate is also busy with other matters.

I apologize for any inconvenience. We’ll return next week with an update to the forecasting model of U.S. GDP and, possibly, with some updates on Iran’s missile capabilities.

Tuomas

1. Why the Persian Gulf theater is highly unfavorable to the U.S. in any conflict with Iran (by Patricia Marins)

2. The strategic depth of Iran and the Strait of Hormuz.

3. What does President Trump want with Iran?

4. Conclusion: Assessment on the likelihood of the war.

This week, we’ll concentrate on the looming war between the Israel-U.S. vs. Iran. Two weeks ago, we sketched a worst-case scenario for Israel with Brazil-based geopolitical analysts, Patrician Marins. This week we’ll continue to cooperate with her by digging deeper into the conflict. We provide this information to you, because the grave threat Iran would pose to the U.S. in the case of a full-scale conflict, has not been explained practically anywhere.

We start with a piece by Patricia detailing why the Iran holds a formidable upper-hand in any full-scale naval (aerial) conflict with the U.S.-Israel axis. The main point of her piece is that we have seen only a glimpse of the capabilities of Iran, which are being downplayed by the mainstream media.

We continue with a joint analysis detailing the strategic depth Iran is holding. It ranges from the support of the Iranian populace for their leadership, cemented by the covert war to the (likely) unwavering support of Russia and China.

We end with the speculation of why President Trump seems to hellbent to attack Iran. The Grand (Unified) Geopolitical Theory, which first part we published four weeks ago, implies that the war, if it comes, is not about oil or even Iranian enrichment, but on the strategic role Iran holds, not just in the Middle East but also globally.

Tuomas

Why the Persian Gulf theater is highly unfavorable to the U.S. in any conflict with Iran

By Patricia Marins

The problem for President Trump is not the number of American ships sent to intimidate Iran. The real issue is the theater of operations itself, its geography, bathymetry, and the asymmetric force Iran has deliberately built to exploit them.

Shallow and Confined Waters

The Persian Gulf is one of the shallowest seas on the planet, with an average depth of just 35–50 meters and a maximum of about 120 meters near the Strait of Hormuz. These shallow, high-salinity, and high-temperature conditions create a challenging, noisy, and complex environment for sonar, favoring small, fast, and highly maneuverable platforms. The Gulf of Oman is deeper; however, along the Iranian coast remains relatively shallow, with depths averaging around 200 m, with Iran operating 5-6 larger submarines (Kilo and Fateh classes) in those waters and in Arabian sea.

A U.S. Carrier Strike Group (CSG) cannot operate inside these gulfs without extreme risk. Even if positioned 1,500 km offshore in the Arabian Sea, American ships remain within range of Iranian missiles, submarines, and drones. To project power, they must pass through the narrow, shallow choke point of Hormuz, precisely where Iran has concentrated its asymmetric assets. Without closing that distance, carrier-based aircraft lack the range to strike Iran’s major cities, including Tehran.

Iran’s “Mosquito Fleet” - Speedboats and Catamarans

Iran operates at least 1,500 fast attack craft, many displacing less than 10 tons and capable of 50-110 knots. Roughly 250–300 are armed with modern anti-ship missiles (Nasr, Kowsar, Ghader, Zafar). These vessels were designed for classic “swarm” tactics: rapid hit-and-run attacks, saturation strikes, and suicide missions. The U.S. Navy has not faced this kind of strategy since World War II.

Catamarans of Iran are equipped with 16 vertical launch cells for air-defense systems with ranges exceeding 100 km. Some Zulfiqar-class speedboats are also dedicated to air defense.

Submarines Optimized for Littoral Warfare

Iran possesses one of the largest and most diverse submarine fleets in the Middle East - an estimated 28-30 boats. About 20 of them are Ghadir-class midget submarines: extremely quiet in shallow water, capable of laying mines, launching torpedoes, and firing submerged anti-ship missiles. Like the fast boats, they can resupply at any small pier if their main bases are destroyed.

These 20+ mini-submarines turn the shallow waters into a lethal ambush zone. Large U.S. submarines (Ohio or Virginia class) would struggle to maneuver and could be hunted by dozens of stealthy mini-subs. In the deeper waters of the Gulf of Oman, American forces would still face the 5-6 larger Fateh and Kilo-class boats.

Unmanned Systems

UUVs (Unmanned Underwater Vehicles)

Iran has invested heavily in unmanned underwater systems, ranging from the Nazir-1 and Nazir-5 to a sophisticated XLUUV (Extra-Large Unmanned Underwater Vehicle) model, which Iranian officials claim is comparable to the U.S. Navy’s Orca.

Furthermore, Iran has invested heavily in torpedo-shaped UUVs. These hybrid weapons can loiter for extended periods, are remotely guided, and are designed to attack stationary or slow-moving targets. Their range and endurance far exceed those of conventional torpedoes, making them particularly dangerous in confined waters.

USVs (Unmanned Surface Vehicles)

Iran has demonstrated explosive unmanned surface vessels and swarm tactics, often operating alongside manned speedboats. It has also supplied several models to the Houthis. There are dozens of variants, some AI-equipped, reaching speeds over 120 km/h and ranges of several hundred kilometers.

UAVs (Unmanned Aerial Vehicles)

Iran currently deploys approximately 20 distinct drone models, with the Shahed-136B standing out due to its significantly upgraded range of up to 4,000 km. Other pivotal systems include the Shahed-149 ‘Gaza’, the Ababil, and the Mohajer series, which are essential for ISR (Intelligence, Surveillance, and Reconnaissance) and coordinating anti-ship strikes. Additionally, the Karrar serves as a versatile platform capable of carrying air-to-air missiles for aerial engagements. By leveraging these low-cost, high-endurance systems, Iran can effectively saturate enemy defenses with minimal financial investment.

U.S. Bases Are Dangerously Exposed

Most American forward bases lie perilously close to Iran. Al-Udeid Air Base (Qatar) is less than 300 km from the Iranian coast (a facility that cost roughly $10 billion). The U.S. 5th Fleet headquarters (Bahrain) is just over 200 km from Iranian territory. The bases held a highly detrimental position in an all-out conflict as Iran has large stocks of older missiles with a range of 300 km. Iran could use them to overwhelm Patriot batteries. Moreover, bases in the UAE, Kuwait, and eastern Saudi Arabia are all within 700 km, well inside the range of Iranian short range missiles and thousands of drones. In case of conflict, it would become impossible to operate these bases, considerably reducing logistical capacity.

Long-Range “Stand-Off” Attacks Are Practically Impossible

Operating from a safe distance (e.g., 1,000 km offshore in the Arabian Sea), carrier aircraft (F/A-18 Super Hornet, F-35C) lack the combat radius to reach deep into Iran, especially Tehran. Aerial refueling would require tankers operating in contested airspace, a high-risk proposition. Even Tomahawk missiles (standard range 1,600–1,700 km, extendable to 2,500 km in some variants) would struggle to hit Tehran from that distance, forcing ships closer to the coast and into greater danger.

There is no realistic scenario of a “limited strike and quick withdrawal.” Iran’s military-industrial base, hardened by decades of sanctions, is built for a prolonged war. Its forces were specifically designed for this environment: shallow waters, short interior lines of communication, and vast numbers of cheap, distributed weapons.

Tehran lies nearly 1,000 km from the coast, far beyond the easy reach of carrier-based aircraft without deep penetration into hostile airspace. The only way to heavily strike the capital would be from bases in Azerbaijan, as Israel appears to have done on two occasions.

Antiship Missiles

Above 700 km

Iran has developed and fielded multiple long-range anti-ship missiles capable of striking targets well beyond the Persian Gulf and into the Arabian Sea.

The three main systems include the Abu Mahdi, a turbojet-powered, sea-skimming anti-ship cruise missile with a confirmed range exceeding 1,000 km. In 2023 the IRGC Navy announced versions reaching 2,000 km and up to 2,600 km in submarine-launched variants. The Qadr-474, is an advanced ship-launched anti-ship cruise missile with a range of 2,000 km, already equipped on IRGC Navy vessels including the Shahid Mahdaviand Shahid Soleimani classes. And, third, the Zolfaghar Basir, an anti-ship ballistic missile (ASBM) with a range exceeding 700 km (some sources claim up to 1,000 km when ship-launched), equipped with an optical seeker optimized for moving ships and launched from mobile coastal or island platforms.

Hypersonic and Long-Range Ballistic Systems for Naval Strike

Iran has adapted and tested several long-range ballistic missiles in the anti-ship role, as the Emad (1,700 km), Ghadr (2,000 km), the Fattah-2, a hypersonic glide vehicle variant with claimed range up to 2,000 km and the Sejji variants(2,500 km). Some were fired more than 1,800 km into the Indian Ocean against simulated naval targets during Great Prophet 15 (January 2021) while a U.S. carrier strike group was in the area.

The Iran-China-Russia(-Strait) Play

With Patricia Marins

In the above-described environment, a naval battle heavily favors Iran. Large U.S. surface ships would face a “swarm of mosquitoes” threat the U.S. Navy has not confronted in decades. The risk of significant casualties is high. Even a successful initial strike would likely be followed by rapid Iranian reconstitution, supported most likely by China and Russia, leaving the regime intact and its stock of enriched uranium (currently reportedly 440 kg) still in its hands. Only a large-scale ground operation would be sufficient to deliver the “strategic goals” the U.S. president has asserted (we return to these below).

The information Tuomas received from his Finnish-Iranian contact at the end of last week indicates that the momentum is changing in favor of Tehran. The country stands united with its leadership enjoying support it has not seen in decades. This forms a notable “strategic” support for the Iranian leadership to act as it sees fit against any foreign or domestic enemy. In addition, there are two strategical aspects supporting the Iranian regime.

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This week, we’ll start by updating the economic indicators. They continue to convey a mixed message. Previously, we had interpreted this controversy as a sign of approaching turbulence. The analysis and forecasts we present herein enforce this view.

On the geopolitical front, we ponder the question, when do we reach peace in Ukraine? Yesterday, I noted the new “bizarre” deadline of June created, reportedly, by an ultimatum from President Trump to President Zelenskyy to hold elections and a referendum on land concessions “or else (maybe).” At the same time, Finnish president Alexander Stubb has changed his tone from aggressive to something resembling a détente (towards Russia), which indicates that the global elite have started to turn to “dialogue.” Based on these, our assessment of the prospects of peace is elevated. However, we should keep in mind that we were too optimistic also after the Anchorage summit of presidents Putin and Trump.

We end with an effort to shed light into the divergence in OECD’s leading indicators through (further) statistical modeling. Our forecasts indicate, yet again, that the global business cycle would turn down during Q2, to which Beijing would respond by ramping up the credit machine yet again.

Tuomas

Economic indicators

United States, January (December)

Richmond Fed manufacturing: -6 (-7)

Empire State manufacturing: 7.7 (-3.9)

Dallas Fed manufacturing: 11.2 (-3.2)

Kansas Fed manufacturing: 0 (0)

Manufacturing PMI: 52.4 (51.8)

Services PMI: 52.7 (52.5)

Consumer Confidence: 84.5 (94.2)

U.S. leading indicator; November (September): 97.9 (98.3)

Economic indicators paint a conflicting picture on the state of the U.S. economy. Manufacturing sector posted a clear rebound from past month continuing the slow recovery from its 2022 - 2024 slump.

However, consumer confidence published by the Conference Board collapsed below Corona lockdown depths. More damningly, the expectations index continued to sunk signaling a deepening forward-looking pessimism among the U.S. households.

The now-resumed leading indicator of the U.S. also declined in October and November. It has now continued to “nose-dive” for about four years.

The conflicting message sent by the economic indicators continues to emphasize our hypothesis that something is “brewing” in the U.S. economy. The sinking of consumer confidence indicates that household consumption can simply collapse, and the fact that expectations continue to sink indicates the likelihood of this growing. This is what our forecasting model may observe approaching, as it continues to predict an U.S. recession starting from next quarter.

Eurozone, January (December)

Manufacturing PMI: 49.5 (48.8)

Services PMI: 51.6 (52.4)

Germany ifo Business Climate: 87.6 (87.6)

While the manufacturing PMI of the Eurozone edged up, it still signaled contraction (value under 50). The ifo Business Climate index remained depressed, but did not fall further. A German economist Thomas Kolbe published an interesting piece on the recent “strength” of the German economy in Zerohedge. In it he notes that:

For December 2025, Germany’s Federal Statistics Office reported a 7.6% month-on-month jump in industrial orders. November had already provided a first boost with a rise of over 5%—right in the midst of a severe economic crisis.

But once you dissect the data and strip out large orders, a very different picture emerges. The apparent surge in orders shrinks to a mere 0.9%.

What happened? Experience shows that this comes from “Other Vehicle Manufacturing,” which jumped roughly 9.5%. This category is dominated by defense equipment. In short: the federal government’s debt-financed special fund has found its way into German military production.

This somewhat confirms what we speculated to be behind the divergence between OECD’s leading indicators of China and major four European nations in the Weekly Forecasts 42/2025, where we noted that:

The decoupling of Major-4 Europe from China all through the year is notable. While it has been just nine months, it is difficult to find another such long divergence from the data dating back to May 1992. This is likely a result of the deficit and war spending of governments, with, for example, Germany enacting major deficit spending aimed at infrastructure, security, and the military.

Our updated forecasts (see below) expect this divergence to continue to grow only for few months.

China, December (November)

Caixin (RatingDog) manufacturing PMI: 50.3 (50.1)

NBS manufacturing PMI: 49.3 (50.1)

Caixin (RatingDog) services PMI: 52.3 (52.0)

Our forecasting model anticipated an increase in the stimulus entering the Chinese economy in its last update in Weekly Forecasts 3/2026. The small uptick observed in the Caixin (RatingDog) manufacturing and services PMIs would is in line with this. However, the collapse of Fixed Asset Investments, i.e., investments on land, buildings, machinery, and technology, of China into the negative is a troubling sign for the Chinese economy going forward.

Excluding the Corona lockdowns of 2020, 2025 actually saw the first annual decline in the investments since 1989, when China experienced an economic crisis caused by runaway inflation and collapse in industrial profits (and hence production). While the collapse is now mainly driven by a drastic fall in property investments, investments in other sectors have failed to cover for it. At this point, it would be important for the services sector to start to grow rapidly through household consumption to carry the Chinese economy. However, like Tuomas noted in Exit the Dragon, Chinese consumer is maxed out. These imply both declining economy momentum from China as well as increased stimulus by Beijing to counter it. This is also what our forecasting model is anticipating.

Peace in Ukraine, when?

We have not analyzed the war in Ukraine for a while. This is because there has not been a lot to analyze, as the war has grinded on, mercilessly. In the Weekly Forecasts 2/2024 we warned that

We can now conclude that our somewhat optimistic timeline for peace did not come to be. This is mostly because Presidents Trump and Putin were unable to seize the momentum reached in Anchorage. The jury is still out for the pessimistic part (another conflict), but at current time it also looks to fail also (which would be most welcome).

As a result of this failure, our post-Anchorage assessment on the likelihood of a peace reached in the coming (three) months turned out too optimistic also. We estimated that the likelihood of a peace reached within the following three months was 85% while, for example, Grok-4 assessed that the likelihood was only 30-40%. The AI was correct on this one. To our defense, Tuomas warned on yet another failure by President Trump in Ukraine just three weeks after the Anchorage summit in The Trump failure #3, but he did not formally alter the likelihood.

What are the likelihoods by provided by us vs. Grok-4 now?

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1. A worst-case scenario for Israel in the Iran-Israel conflict (with Patricia Marins).

2. Where are we with U.S. inflation?

3. Forecasts for U.S. inflation indicate a deceleration after a short spurt at the start of the year.

We have not been updating our U.S. inflation forecasts for a while. The last time we forecasted U.S. inflation was at the end of September, when Mate ran VAR-GARGH estimations and forecasts on the U.S. Consumer Price Index (CPI) and core inflation series. There are multiple reasons why we have not provided inflation forecasts after that, some of which I will detail below, but the main thing to note is that our September forecasts were rather accurate. They, for example, correctly anticipated the fall of month-over-month change in the U.S. CPI to the negative at the end of the past year.

The problem we have had with forecasting the inflation series, and one of the reasons why we stopped forecasting them for a while, was the unclarity regarding the time series properties of the U.S. consumer price index series. While testing the CPI, the core inflation, and the ‘super-core inflation,’ the problem re-emerged in the test, indicating that the series would be I(1) nonstationary processes, as an assumption we had disregarded previously.

To make a clear judgement of what forecasting method would be more suitable, this week we will present forecasts based on the (assumed) cointegration relationship between the variables. Next week, we’ll update the inflation forecasts from VAR-GARCH modeling. This is done to see which performs the best.

In the geopolitical section, we present a worst-case scenario for Israel in a conflict with Iran. This piece is co-written with Patricia Marins, a Brazil-based geopolitical analyst whom I’ve been following on X for over six months. She’s simply brilliant, and we are investigating venues to expand our cooperation. In the worst-case scenario, Iran will strike the nuclear facility near Dimona, leading to massive retaliation from Israel, igniting a global conflict. Let’s start with it.

Tuomas

The worst-case scenario for Israel in conflict with Iran

Co-written with Patricia Marins.

The worst scenario for Israel would be a large Iranian missile striking the Shimon Peres Negev Nuclear Research Center near the city of Dimona, or the ‘Dimona reactor.’ A successful attack with a missile like the Fattah, breaching the reactor core or fuel storage pools, would not only destroy the containment but also vaporize and fragment the nuclear core. The massive kinetic energy would create a rapidly rising column of heated debris and smoke. This would inject radioactive particles into the atmosphere, rendering entire Israeli cities uninhabitable for decades. If precipitation occurred shortly after the attack, the radiation would be “washed” from the atmosphere and deposited on the ground in concentrated form, making agricultural lands and water reservoirs unusable. This would prompt Israel to respond with nuclear weapons as well, devastating many of Iran’s cities.

At this point, both Russian and U.S. commitment would be weighted and, in the worst-case, Russia would enact a retaliatory strike to Israel with nuclear weapons, basically destroying the country. If the U.S. were to retaliate against Iran or Russia, a global nuclear war would erupt. Essentially, the developments would follow the last three steps of the 10-point worst-case scenario Tuomas envisaged for the war between Israel and Iran.

The key issue here is that Iran has been verified to possess more than 400 kg of uranium enriched to 60%, meaning it is mere weeks away from having enough material for a weapon. In fact, six months ago, Iran already had this material and possesses at least four dual-capable missiles with the range to reach Israel: Emad, Ghadr, Sejjil, Khorramshahr, and their various variants. We have also speculated on the possibility of whether Iran already holds a nuclear weapon. In October 2024, we reported on the strange seismic activity in the Kavir desert, or Dasht-e Kavir (the Great Salt Desert), whose shock waves some researchers attributed to a major (nuclear) explosion. In October, Tuomas wrote about resurfaced speculation that Iran would have purchased nuclear warheads from defunct Muslim states of the Soviet Union in the 1990s. In other words, at the very minimum, Iran can already be considered an ambiguous nuclear power and, in the worst-case, an actual nuclear power. These imply that there could even be an Iranian nuclear response, causing immense devastation that would extend to neighboring countries.

Outside the nuclear realm, the worst scenario would be Iran taking the initiative and launching a barrage of 500 missiles against Israel or using her anti-ship missiles to sink the USS Abraham Lincoln. The former would be a devastating scenario for Israel. Broadly speaking, data from the American fleet and THAAD systems show poor interception rates during the 12-day war. Imagine then that more than 400 missiles with warheads over 1 ton hit cities like Tel Aviv. A barrage of this size would not be a problem for Iran. About a year ago, intelligence services estimated that Iran operated 600 missile cities, with most of them operating multiple silos. This would lead the US to intervene and, together with Israel, attack Iran with all the might they possess. The latter would naturally be a huge embarrassment to the U.S., threatening the façade of U.S. military might. As Tuomas noted in “Inching Towards the Doomsday,” only a massive retaliation with nuclear weapons would be sufficient to restore the situation.

Where we are now is that Iran has signaled multiple times, even with the mouth of Supreme Leader Ali Khamenei, that Iran will consider all U.S.-Israel attacks as existential threats and that it will respond accordingly. While we do consider it unlikely that the IRGC (Islamic Revolutionary Guard Corps) would target the ‘Dimona reactor’ or USS Abraham Lincoln in the early stages of a re-emerged conflict, we need to acknowledge that Iran holds this power. Understanding this, we now wait for what comes out the negotiations, which started today in Muscat (Oman).

Where are we with U.S. inflation?

Due to the government shutdown, there was no publication of the inflation indices in the U.S. in October. We approximated the October numbers by averaging over the September and November numbers, i.e., we calculated an average of those two to come up with an estimate for the October inflation figures. What most seem to have missed is that U.S. inflation fell from September to November.

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1. GDP growth forecasts.

2. Why President Trump seems so keen of making a (likely catastrophic) mistake in the Middle East?

3. Are OECD’s leading indicators signaling a turn into a global downturn and towards a recession?

Probably everyone who dares is currently waiting in anxiety for what President Trump will decide to do in the Middle East. I consider that his “Armada” is there more just as a show of force than to start on actual war, but it is becoming more and more difficult for him to simply walk away each passing day. The situation appears chaotic, and decisions to strike vs. not strike can come and go in a whisk (we may have been in such a setup for a while already).

In this week’s forecasts, we explain the background of the current campaign against Iran. There is unlikely to be any single reason for the aggression, but rather a complex geopolitical “maze.” We consider that it involves the petrodollar trade and the threat of China, as well as aspirations arising from the main ally of the U.S. in the region, i.e., Israel.

We also update our forecasts for the GDP growth and encipher the recent signals of the leading indicators of the OECD through statistical analysis and forecasting. The main message of our economic forecasts continues to be that a downturn is approaching.

Tuomas

GDP growth forecasts

This is how our last forecasts for Q4 GDP growth looked like at the end of December. We were expecting the U.S. GDP to have grown at a 0.8% rate quarter-to-quarter, 3.2% annualized, and the Finnish GDP at a rate of 0.5% (Q-to-Q). Our forecasts expected the Eurozone economy would have stagnated.

We will only get the first estimate for the growth of U.S. Q4 GDP in February, like that of Finland’s. Today, Eurostat published the first estimate for the growth rate of the Eurozone for Q4, which was 0.3%. Our last estimate from December was 0%, so we missed big to the downside. Here are our latest GDP growth forecasts.

Our nowcasts (with data reaching to the end of December) are now indicating that both the U.S. and Finnish economies would have accelerated notably during Q4. In accordance with our forecasting model (see below), we are forecasting that the acceleration of the U.S. will continue during this quarter but then hit a wall in Q2. We forecast the Eurozone economy to also pick up pace during this quarter before entering into a slump in Q2. We have to note that the Q2-Q3 decline in the growth rates is driven fully by our medium-term forecasting model for the U.S. and by our forecasts for OECD’s leading indicators presented below. Both of these forecasts include a heavy dose of uncertainty. Moreover, there are no shortages of potential shocks, one of which we list below. Every growth forecast for this year thus needs to be taken with a heavy grain of salt.

Our medium-term forecasting model thus keeps on anticipating the U.S. economy to pick up speed before crashing during the next two quarters. This result continues to baffle us, but as Tuomas has discussed this extensively during the past week (see, e.g., this and this), we do not comment on the result any further here. Let’s wait and see what comes.

Chaos looms in the Middle East, but why?

As of the time of writing, the situation around Iran looks precarious. There are no clear indications that U.S.-Israel strikes on Iran would be imminent, but the pressure is building. Tuomas has warned of the implications of such catastrophic escalation several times in recent weeks. Here we detail some Iranian capabilities affecting the decisions of President Trump and offer some conjecture as to why the U.S.-Israel axis seems so hellbent to deliver a regime change in Iran.

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1. The economic outlook of China.

2. The Grand (Unified) Geopolitical Theory, Part I: Ensuring U.S. dominance through a conflict in Europe.

3. Forecasts for aggregate financing of the economy of China.

I could say that we are finally here. It’s my habit to write an introduction after the analysis is done; a practice that originates from my academic career, during which I authored or co-authored 10 peer-reviewed and several non-peer-reviewed articles. What I mean by “finally here” is that I feel that Weekly Forecasts has finally found its intended structure after “wandering in the shadows” for a year and a half.

In these third weekly forecasts of the year, we detail the economy outlook of China and provide an update to our forecasts on the financial flows to the Chinese economy for 2026. However, the main part of these forecasts is an introduction into my geopolitical-theory framework, which goes under the working title the “Grand (Unified) Geopolitical Theory.” In it, I aim to combine everything I have learned about geopolitics since my early introduction to it, when I was just 13 years old.

In this first part of the theory, I will outline the founding principle of the theory and formulate a theory explaining the war in Ukraine. One of its building blocks is the aimed destruction of the ‘Eurasian alliance,’ which I first learned about in May 2022 from a long-time U.S.-based political journalist, whose name and actual text I have been unable to locate.

The theory and its application paint an unstable near-future for Europe. It also explains why the war in Ukraine has come to be and why peace is so difficult to achieve there. Everything starts with the collapse of the Soviet Union and the resulting failure of the global superpower-stucture. As this is a theory under construction, all comments are highly welcomed.

Tuomas

The economic outlook: China

We have a record!

The accumulated flow of financing to the Chinese economy reached CNY 35.784 trillion in 2025, surpassing the previous record of CNY 35.569 set in 2023. In December, the flow of credit entering the Chinese economy grew by CNY 2,210 billion, which was clearly below the December record of CNY 2,851 billion set in 2024. Still, the December flow of financing was the third highest since our records began (2012). Our forecast for the flow of financing from the past month (in natural logarithms) was accurate, as shown by the figure below.

The realized figure of China’s ‘Social financing’ in December was also safely within the 95% confidence intervals of our August forecast.

Essentially the December figure indicates that the Chinese economy is likely to continue to “muddle through” the H1, like we anticipated a month ago.

Another measure we have been using to assess the outlook of the Chinese economy has been cement production. We have used this measure because around the mid-2010s, the gross domestic product series of China became heavily manipulated. One researcher at the Bank of Finland Institute for Emerging Economies, BOFIT, noted in a lecture at the University of Helsinki that Tuomas attended that the series of China’s GDP should not be used in forecasting, because the final figure is always decided by the Prime Minister. There is also statistical evidence of the GDP series of China being “manufactured,” but we do not go there now. However, there’s no point in trying to manipulate the cement production series, which is why we have trusted it the most. Figure 4 presents the monthly series of cement production in China for the past 10 years (note that January and February data is periodically missing).

What you notice is a steady decline in the cement production starting in around mid-January 2021. However, like we noted in Weekly Forecasts 10/2025, the forecasting ability of the cement production has declined because Beijing has directed funding away from the real estate sector, which has reached a state of collapse as a result.

This process of blowing one debt bubble after another is the way Beijing has been able to avoid the collapse of the Chinese economy under the massive and ever-growing debt bubble. Beijing holds something of a command-and-control grip on the Chinese banking sector, which means that it can order banks to lend and direct their lending to different sectors. During the past five years, following the enactment of the “three red lines” policy concerning the real estate sector in August 2020, we have seen this in full-swing with Beijing directing the debt creation to manufacturing and AI sectors. The problem Beijing has is that to keep economy growing, debt needs to grow much faster. This has led to the economic “perversion” shown in Figure 5.

Even in a command-and-control economy this cannot be sustained indefinitely. At the end of 2024, the debt-to-GDP ratio of China stood at staggering 294%, and we do not consider this to hold all the debt.

The question for China’s outlook is, will Beijing be able to contain the collapse to the real estate sector? While it currently looks so, we have our doubts. We return to this later.

The failure of the superpower-structure and the control of Europe

Many have viewed the recent developments in the geopolitical (global) arena with worry. This, naturally, includes us. We have been analyzing, speculating on, and forecasting dire developments during the past two years, of which a worryingly high percentage has become a reality. What we will present, or start to sketch here, is a Grand (Unified) Geopolitical Theory mapping the geopolitical transition, or a rupture, as (blatantly) put by Canadian Prime Minister Mark Carney in Davos earlier this week This effort aims to connect seemingly unrelated yet coordinated geopolitical developments that have unfolded globally over the past 30 years, launched by the fall of the Soviet Union. The theory will have a central role in this section in the coming months.

The collapse of the Soviet Union led to the failing of the superpower-structure, which had dominated the world since the Second World War. Many still consider that the creation of the supranational-structure, enshrined in the supranational entities, like the United Nations and the International Monetary Fund, was behind the long period without major wars in Europe and relative calm elsewhere. However, recent developments reveal that it was actually the superpower-structure that enforced the period of (relative) peace and prosperity in Europe and the ability of the supranational structure to function (somewhat) properly in the world. The failure of the one superpower, the Soviet Union, caused the ambitions of the other superpower (the U.S.) to be unleashed, leading us to the current predicament.

What makes this so detrimental for the world is the fact that the strongest “glue” holding an empire and a nation-state (or a state-nation) together is a threat. A threat of a foreign enemy attacking the values of the nation entity or destroying it. This leads to the first founding principle of the Grand (Unified) Geopolitical Theory,1 which is that the survival of an empire, a nation holding a global hegemony, requires an enemy, true or imagined. An “enemy” feeds the drive for policies undermining the needs of the people on behalf of investments in defense industries. It creates the justification for silencing dissidents and enacting control measures to “protect” the populace. Most importantly, however, a threat of an enemy creates a justification for strong leadership, which is oftentimes epitomized in the form of a strong leader.

Europe became the epicenter of the failure of the superpower-structure essentially right after the fall of the Soviet Union. The enlargement of both the North Atlantic Treaty Organization, or NATO, and the creation of the European Union in 1993 are symptoms of this. In February 2022, the failure of the superpower-structure led to the first major war on the European continent since 1945.

Dr. Zbigniew Brzezinski, one of the most, if not the most, influential political scientists thus far and a relentless promoter of NATO enlargement, warned in 2009 the NATO leadership not to “unintentionally reinforce Russia’s imperial nostalgia regarding Ukraine and Georgia.” What he spoke against was the enlargement of NATO into those countries, or even efforts towards such, without the consent and cooperation with Russia. However, he went even further than that to shield Europe and the world from a likely catastrophe.

In the same piece, Dr. Brzezinski proposed a joint security structure between NATO and the Collective Security Treaty Organization, or CSTO, a currently practically forgotten security apparatus created by the Kremlin to replace the Warsaw Pact. His views most likely echoed the Kremlin’s stated aim of seeking a deep détente. In 2021, George Robertson, a former Labour defense secretary who led NATO between 1999 and 2003, stated in an interview that, in the first meeting with President Putin as a head of NATO, it became clear that: “They [Russia] wanted to be part of that secure, stable, prosperous west [Western Europe] that Russia was out of at the time.” However, none of this materialized, as NATO took a path that was the exact opposite of the one proposed by Dr. Brzezinski, a prominent NATO hawk, and completely ignored the olive branch offered by President Putin. Why?

We currently consider that the answer lies in the agenda, combining the views of the neocon faction operating within the U.S. government with the control of Europe, as proposed by Dr. Brzezinski in his seminal piece, The Grand Chessboard: American Primacy and Its Geostrategic Imperatives, published in 1997. An excerpt from the book:

It follows that a wider Europe and an enlarged NATO will serve well both the short-term and the longer-term goals of U.S. policy. A larger Europe will expand the range of American influence-- and, through the admission of new Central European members, also increase in the European councils the number of states with a pro-American proclivity-- without simultaneously creating a Europe politically so integrated that it could soon challenge the United States on geopolitical matters of high importance to America elsewhere, particularly in the Middle East.

Effectively, Zbigniew emphasized the U.S. administration(s) to advance both the creation of the European Union (1993) and NATO enlargement, because both would grow the influence of the U.S. in Europe and neighboring regions without creating an actually unified Europe. Zbigniew likely viewed the European Union as a fragile entity, given that nation-states with centuries or millennia of history are, most likely, incapable of forming a functional union. Such a “semi-union” would be easily controlled by the U.S. Furthermore, controlling a (semi-)union would be simpler than managing a group of independent states. As the U.S. holds a dominant role in NATO, its enlargement would spread the influence of Washington slavishly.

However, the proposed enlargement and thus inevitable empowerment of the EU created a major risk. An economic axis could form between China, Russia, and the EU, where China would provide the workforce, Russia the energy, and the EU the capital and know-how to create a mutually enforcing economic alliance growing and integrating rapidly. Such an alliance would empower each actor (China, Russia, and the EU), resulting in two detrimental developments for the U.S.:

1. The European Union outgrowing the U.S. reach (reaching “independence”).

2. A creation of a ‘Eurasian alliance’ rising to challenge the hegemony of the U.S. both politically and economically.

Therefore, at some point, the U.S. would need to establish a firm control of the EU by severing or at least seriously damaging the ties to China and Russia. Nothing naturally would accomplish this better than a war.

The intellect of Dr. Brzezinski provided a way into this (note that he died on 26 May 2017) with minimal risk of a nuclear war. All NATO needed to do was attempt to expand into Georgia and Ukraine, which would compel Russia to respond. Pushing these efforts far enough would trigger a military response. It is likely that the Russia-Georgia war, fought in August 2008, was a test for the Pentagon and NATO leadership to see whether the strategy would work, and it did. It implied that Russia would respond to a similar threat in Ukraine with force. Moreover, when such a point was reached in Ukraine, all Washington needed to do was launch a propaganda campaign labeling Russia as an imminent threat to “freedom” and to Europe. With the help of selected European leaders, the campaign would, most likely, bring about a separation of Europe from China and Russia.

The first part of our theory has outlined a likely roadmap and identified the driving forces behind the war in Ukraine. As noted above, this is a theory, so corrections and additions to it are both inevitable and welcome. Even in its current form, the theory provides a plausible explanation for the war in Ukraine and the challenges of achieving peace, specifically because any peace agreement must prevent the reanimation of the Eurasian alliance.

At this point, it is necessary also to note that our theory does not take any stand against the aspirations of people in respective countries to seek shelter against the possible aggression by Russia. This is a model (theory) for explaining what has happened and for forecasting what is likely to manifest.

The theory implies that as the U.S. has secured its goals in Europe, a period of détente will appear, but only in a way that enables Washington to control the EU and its relationship with Russia (and China). This, for its part, indicates that only a fragile peace can be found in Ukraine, or if Ukraine collapses and becomes dominated by Russia, another front needs to be opened, or be ready to be opened, against Russia in Europe (within the EU). This is essentially what we have been warning about for several months, and the theory presented herein reinforces our worry.

Weekly forecasts: Chinese stimulus

Lastly, we update our forecast for the flow of financing into the Chinese economy for the next 12 months. The structure of the ARMA model we have been using to forecast China’s aggregate financing to the real economy has fluctuated over the past six months. While data revisions, updates, and statistical modelling contribute to this fluctuation, the majority of it has been caused by our own actions. We have allowed simplified rules and a sense of urgency to dictate our model selection (our apologies). Now, we revert back to basic model selection criteria, a bit similarly to what we did in August. For those interested, we explain the process behind the creation of the model used in the footnote.2

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1. The economic outlook.

2. The geopolitical outlook.

3. Statistical analysis on the relationship between U.S. GDP and public debt.

Like I noted in December, I have been planning for a reorganization of our Weekly Forecasts service, which has sought its place in our service offering since its launch on 5 September 2024. The service started as an extension of our Black Swan Outlook detailing major global developments. By the end of 2024, I had noticed that this overlap was somewhat problematic. Instead of complementing each other, the Black Swan Outlook and Weekly Forecasts began to undermine one another, as their topics overlapped in a “predatory manner.” It became difficult to produce high-quality content for both services.

This problem became exacerbated when I launched my Daily Forecasts (originally Daily Thoughts) on 10 February, 2025. My solution was to turn the Weekly Forecasts into a presentation of the results of statistical analyses and forecasts. This soon turned out rather burdensome but, most troublingly, uninformative. We discussed the issue with Mate on several occasions, with our views differing quite radically at points, but at the end I had to admit his criticism towards the purely statistical nature of Weekly Forecasts was correct. With the ‘craft’ and manpower we possessed, we were unable to produce reliable forecasts, on a large scale, on the complex economic variables. Most importantly, I felt that we were unable to provide our customers with sufficient high-quality content. In October, we returned to the founding idea in a Special Issue, which discarded all of the statistical forecasts. Yet, something was still missing.

The rapidly developing geopolitical and economic landscapes also overwhelmed my daily publications, which were meant to be short analyses (and forecasts) on the very recent developments. The monthly Outlooks, on the other hand, were aimed at analyzing a certain topic. I began to sense a neglect of the broader, overarching picture underlying the developments and our hypotheses successfully explaining and forecasting most of them. In other words, there was a lack of a forum to explain the underlying principles and deeper logic behind our forecasts. This gave rise to the idea of bridging this gap in the Weekly Forecasts.

In this second weekly forecast of the year, I unveil this concept to you. I urge you to look at this as an evolving process, and we would especially like to hear your comments on the change, i.e., what topics would you like for us to cover or analyze more deeply?

It is also my plan for the year to extend the range of our (publicly visible) contributors. Without going into specifics at this point, I have started talks for partnering up with analysts covering the topics of interest (economy, finance, and geopolitics). I am confident that by the end of this year (possibly sooner), we will be able to bring to you deeper analyses and forecasts from a wider range of topics through our new contributors.

Tuomas

Economic Outlook

In this section of the (new) Weekly Forecasts, we will follow, for example, the economic indicators, updated monthly. They provide important information on the current state and near future of the world economy, especially when followed collectively (jointly). In the following entries, we will also provide time-series observations of the indicators, which makes it easier to “decipher” their (joint) message. Please note that the publication of the leading indicator of the U.S. has been discontinued for reasons unknown at this point.1

Economic indicators

United States, December (November)

Richmond Fed manufacturing: -7 (-14) Errata corrected on 2/10/2026.

Empire State manufacturing: -3.9 (18.7)

Dallas Fed manufacturing: -3.2 (20.5)

Kansas Fed manufacturing: 0 (7) Errata corrected on 2/10/2026.

Manufacturing PMI: 51.8 (52.2)

Services PMI: 52.5 (54.1)

Consumer Confidence: 89.1 (92.9)

U.S. leading indicator: -- (--)

Eurozone, December (November)

Manufacturing PMI: 48.8 (49.6)

Services PMI: 52.4 (53.6)

Germany ifo Business Climate: 87.6 (88.0)

China, December (November)

Caixin (RatingDog) manufacturing PMI: 50.1 (49.8)

NBS manufacturing PMI: 50.1 (49.2)

Caixin (RatingDog) services PMI: 52.0 (52.1)

Let’s start with China. Like we noted in December, the flow of financing into the Chinese economy had grown in November at par with previous Novembers marked with strong stimulus. In other words, the flow of credit into the Chinese economy was strong in November, which implied an improvement in the PMI prints (October had seen a collapse in stimulus), which materialized. We can expect the Chinese economy to “muddle through” during H1 for the same reasons (see our forecasts).

Figure 1 presents the time series of the Business Climate Survey of the ifo Institute. We can see that the expectations of German businesses improved during H1 2025. However, the assessment of the business situation remained abysmal all through the year, while the business climate observed by German businesses improved marginally during H1. All indices started falling again during H2. Essentially, the German economy is not in a state of collapse but in a state of prolonged and deepening stagnation. This year’s expected (military) stimulus is likely to improve the situation, which implies that we would see something of a recovery of the German and Eurozone economies.

The new orders of U.S. manufacturing firms exhibit a similar trend, somewhat.

The U.S. manufacturing sector, based on new orders it received, entered a stagnation in 2022, following both the rapid interest rate hikes of the Federal Reserve, commencing in April 2022, and the Russo-Ukrainian war, which started in late February 2022. In 2025, the rate of decline (month-over-month change) of the indices seems to have eased, and February and August saw the first positive prints in the (average) of the new orders index since April 2022. At this point, it is unclear whether this trend of recovery lasts.

What we can deduce from the above is that there was something of a semi-recovery in the German (Eurozone) and U.S. economies during 2025, but stagnation looks to continue. It is interesting to see what next quarter brings. Like we have noted several times, our new forecasting model has been consistently anticipating a sudden and drastic turn of the U.S. economy into recession during Q2 and Q3. But as we do not know what the model sees or whether what it sees holds (statistical models, like humans, are fallible), we need to consider the forecast unreliable.

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Geopolitical outlook

We need to address a few things before we start this new section. Our long-term paid subscribers naturally know the scope and nature of our analyses and forecasts, but it is good to clarify it to our new ones.

Like the title of this service insinuates, this is a forecasting outlook. In geopolitics this implies that we need to enter the realm of speculation to be able to map out the coming developments much more than, e.g., in matters concerning the economy or the financial sector. This is for the simple reason that the data on geopolitical developments, unlike e.g. data on economic occurrences, and aspirations behind decisions is rarely brought into the public eye but after an extensive lag (after years or decades; if even then). Because we want to provide you a geopolitical roadmap, the above implies that A) we will speculate on the worst- and best-case geopolitical scenarios, B) we will be wrong at times, but that C) we will learn (openly) and correct our assessments and forecasts accordingly.

That said, let’s now start this new section with a look at the policies of President Trump, which are naturally dominating the global geopolitical landscape. We have been analyzing and forecasting his policies and decisions since his election in November 2024. Unfortunately, our main worry, i.e., the failure to reach a peace in Ukraine, which we formalized after his inauguration a year ago, has become a reality:

After the “extraction” of Venezuelan President Nicolas Maduro, the U.S. president has turned his eye towards Greenland. In the footnote of last January’s Black Swan Outlook, we presented three hypotheses behind President Trump’s interest in Greenland:

The first one is that President Trump has his eye on the vast mineral resources held by both nations. Greenland, e.g., holds vast deposits of crucial minerals, including the so called rare earth elements, crucial for the digital era. The U.S. military requires several rare earth minerals, but especially metalloid antimony which is needed for, e.g., communication equipment, night vision goggles, explosives, ammunition, nuclear weapons, submarines, warships, optics and laser sighting. China currently produces around 48% of the global supply of antimony, accounting for 63% of U.S. imports of antimony. In December, China announced an export ban on antimony and several other minerals crucial for high-tech products. A vast deposit of antimony was just recently discovered from Greenland.

The second hypothesis is that the spoken aim of President Trump to acquire Canada and Greenland arise from preparation for future cataclysmic events. These may include wars, devastating global pandemics and even major natural events, like the pole-shift. It has been speculated since the first term of President Trump that he’s an advocate of global cooling, not warming.

These lead to hypothesis #3, which is that some powerful lobbying organization/people in his background are pushing for an actual annexation of Greenland and Canada for one or both of the two reasons outlined above. While we consider this unlikely at this point, it’s an option we have to acknowledge.

Now, we like to add a fourth one, also correcting and reformulating the third one, which is that the U.S. is unwilling to abandon the Arctic to the “mercy” of the Nordics and Russia (China). What one should understand is that decisions of military action of the U.S. do not generally come from the White House, but from the Pentagon. This is not to say that the U.S. President could not order smaller campaigns “independently,” i.e., by giving an order to the Pentagon to plan and execute a strike. However, all major operations are being planned, monitored, executed, and effectively decided by the Pentagon. From The Venezuelan Oil Narative is PURE THEATRE, by Tracy Shuchart:

The Pentagon approved this operation because Venezuela presented a convergence of strategic threats from all three major US adversaries that exceeded the threshold for military action, with each adversary establishing operational presence that created compounding strategic vulnerabilities.

According to Tracy, the Venezuelan operation was conducted because critical thresholds for A) Beijing’s mineral resource control, B) Iranian weapons manufacturing, and C) Russian military integration were breached. We concur, but want to add that the timing of the strike was probably determined, or at least affected, by a third party, the government of Israel, because Venezuela was an important source of dollar liquidity for Iran. We currently assess that Prime Minister Netanyahu’s government believed the time was right to initiate the covert war in Iran, which they had likely planned for a long time. By the end of the year, the “maximum pressure” campaign enacted by President Donald Trump on February 4, 2025, had reached a point, where any major disruption in the dollar liquidity of Iran would cause an imminent price shock, as retailers would be unable to cover the demand for certain necessities.2 The U.S. created a crippling dollar shortage in Venezuela by removing President Maduro—an action likely planned in collaboration with the military and his successor, Delcy Rodríguez—and by ensuring that the bilateral crude-USD exchange ceased, which led to major price hikes and protests. As explained by Tuomas yesterday, it looks to have been the plan of foreign actors (most likely the CIA and Mossad) to use local (mostly paid) operatives, agents, and special forces to destabilize the Iranian government and possibly to enact wide-ranging sabotaging operations. We consider this to have been a joint operation of the CIA and Mossad, with the latter, in cooperation with the government of PM Netanyahu, deciding when to pull the “trigger,” which occurred at the start of 2026. The process described by Tuomas looks to have stopped now, but we have to wait a while longer for President Trump’s (Pentagon’s) decision.

Coming back to Greenland. The island holds a major role in the Arctic. It holds vast quantities of rare earth minerals the U.S. (Pentagon) desperately craves, and it holds a strategic role in the North Atlantic. We consider that the statement of President Trump that the U.S. needs to “own” Greenland to prevent China and Russia from taking it, reflects the latter, i.e., the worry of the Pentagon that they are losing the Arctic and North Atlantic to the growing dominance of China and Russia. That is, we consider that the statement is actually a statement (worry) that the U.S. military hegemony it has held since the fall of the Soviet Union in 1991 is ending of the Pentagon. Through this prism, we can consider the war in Ukraine as a (successful) attempt to disrupt the creation of the Eurasian alliance. This is what Dr. Zbigniew Brzezinski, the most influential political scholar thus far, instructed the U.S. to do in his magnum opus, The Grand Chessboard: American Primacy and Its Geostrategic Imperatives, published in 1997. An excerpt:

It follows that a wider Europe and an enlarged NATO will serve well both the short-term and the longer-term goals of U.S. policy. A larger Europe will expand the range of American influence-- and, through the admission of new Central European members, also increase in the European councils the number of states with a pro-American proclivity-- without simultaneously creating a Europe politically so integrated that it could soon challenge the United States on geopolitical matters of high importance to America elsewhere, particularly in the Middle East.

What we are thus likely to be seeing is a panic at the Pentagon to sustain the American supremacy in the world it has used to hold for three decades, which is reflected in President Trump’s “decisions,” some of which go almost squarely against his campaign promises. No U.S. president wants to preside over a declining U.S. influence, a bit similarly to how Roman emperors did not want to preside over a declining empire (barring some exceptions).

The fear that the U.S. would come under threat, due to losing its strategic advantage and supply chains of weapons manufacturing falling into the hands of “enemies,” is likely to intermingle with the aim of the neocons to rule over the world in the Pentagon. The fear of the end of an empire is a very dangerous foreign policy doctrine, as it is likely to lead to desperate actions. We consider that we have seen just the first glimpses of this desperation.

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Statistical analysis on the relationship between U.S. GDP and public debt

In this section, we will provide statistical analyses with timely economic and financial variables. The idea is to shed light on complex economic and financial topics through rigorous statistical analysis and forecasting.

This week, we open this section by taking a look at the relationship between U.S. public debt and gross domestic product (GDP).3 We thus extend our previous analyses and forecasts on the U.S. fiscal deficit by treating it as a possible factor driving economic growth. Public debt and the debt sustainability of the U.S. economy have been a focal point since President Biden ran a Great Depression-style fiscal stimulus all through his term. This essentially meant that the Corona stimulus, first enacted in March 2020, never ended.

As usual, let’s start with a visual inspection. Figure 3 presents the time series of the real gross private domestic investments, the real GDP, and the total federal debt of the United States.

What we notice from the figure above is that there look to be three periods of acceleration in the time series of U.S. public debt. The first would occur in the early 1980s and die out in the late 1990s. The second would emerge in two phases, with the first commencing in the early 2000s and the second after the GFC in the late 2000s. The last one, where the U.S. currently resides, would emerge at the start of the 2020s, during and after Covid. However, standard presentation of rapidly growing time series masks the true level of change (growth), because the scale changes. That is, the change from 100 to 1000 is much bigger than the change from 1000 to 2000, while the latter appears larger in simple visual inspection. Like we have been teaching you, you can uncover the true growth of a time series variable through logarithms, which change the changes in levels into changes in the growth rate. Figure 4 presents the natural logarithmic time series of U.S. public debt.

Figure 4 shows that there have been four phases of acceleration in the U.S. government’s debt uptake, but the timing of these phases differs from what we observed in the figure above. The acceleration phases in the U.S. public debt have occurred in the late 1970s, early 1980s, early 2000s, and late 2000s. There was no acceleration in the growth rate of U.S. public debt after Covid, but just a one-off jump in the level of public debt, after which its growth trend has remained more or less the same. In other words, while the U.S. public debt would look to be in something of an exponential trend based on Figure 4, in actuality its growth rate (outside the jump from March to April 2020) has remained more or less the same ever since the Great Financial Crisis.

Time series analysis reveals that the two series (real GDP and U.S. federal public debt) are integrated of order 1. Moreover, cointegration tests indicate that the two series share the same stochastic trend. These results provide a good starting point for further analyses.

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1. Comparisons of the pessimistic and optimistic scenarios vs. realized developments in 2025. (Free)

2. The optimistic (best-case) scenario for 2026. (Free)

3. The pessimistic (worst-case) scenario for 2026. (Free)

4. Scenario likelihoods. (Paywalled)

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So, over the past weekend, we saw one of our forecasts for 2026 become a reality when the U.S. moved to enact a regime change, kind of, in Venezuela. We noted in our most likely scenario for 2026, published on 31 December, that “President Maduro will be forced out of power in Venezuela, relinquishing the Venezuelan oil fields (the largest reserve in the world) to U.S. control.” This is now in motion, but the “extraction” of President Maduro was not just about oil, like I noted here and here.

Moreover, as noted in our December Black Swan Outlook, our most likely (consensus) scenario for 2025 was fairly accurate. Unfortunately, like we note below, the developments in the world followed something of a combination of our pessimistic and consensus scenarios.

I would have preferred not to see this combination, as it essentially suggests that the peak escalation hypothesis I formulated after the Hamas attack on Israel on October 7, 2023, is accurate. This, for its part, implies the existence of the War Triad. I am not ready to announce these hypotheses as correct, factual representations of the actual world, yet, but I am getting very close to doing so. This is because the forecasting ability of these hypotheses indicates the existence of sinister forces in the world that are pushing us towards a global conflict. Our optimistic and pessimistic scenarios naturally reflect this result.

Tuomas

The worst- and best-case scenarios for 2025

In our optimistic and pessimistic scenarios for 2025, we envisaged two very different states of the world. In many cases, they were, unsurprisingly, the complete opposites. Our optimistic (best-case) scenario, for example, envisaged the following developments for 2025:

1. Peace in Ukraine and a (lasting) ceasefire in the Middle East.

2. President Trump cuts federal deficit in a moderate fashion.

3. Beijing continues its cautious balancing act between stimulus and de-leveraging.

4. Central banks keep interest rates relatively high to counter the sustained inflation pressures.

Our pessimistic (worst-case) scenario turned these into their opposites:

1. War in Ukraine escalates into a (frozen) conflict between Russia and NATO.

   1. (Followed by eight ladders of escalation: see below).

2. Emerging economies face an avalanche of sovereign defaults.

   • At first, this pushes investors into USD and Treasuries, but the failure of President Trump to cut the federal deficit, while simultaneously enacting tax-cuts, leads to an acute stress in the U.S. bond markets with failed auctions of Treasuries.

3. China faces her first nation-wide bank run.

4. Central banks are forced to start another round of tightening.

From the optimistic scenario, #1 and #2 clearly did not come to be, but #3 and #4 did, somewhat.

Regarding the war in Ukraine, we have seen some of our steps of our worst-case scenario come true. The envisaged ladders of escalation were:

1. NATO/Ukraine continue with their missile strikes deep into Russia.

2. Russia retaliates with missile strikes and air raids.

3. Before or right after the inauguration of President Trump (January 20), NATO/Ukraine launches a devastating attack to Moscow.

4. Russia retaliates with Oreshnik strikes to Kiev.

5. The peace proposal of President Trump is ‘dead-in-the-water’ as he tries to bully President Putin into peace, e.g., by threatening to double the military aid to Ukraine unless Russian troops are withdrawn from many of the regions they have taken.

6. President Putin declines the offer, and Russia launches a major offensive with Russian troops pushing through the lines of the AFU (Armed Forces of Ukraine) reaching the river Dniepr.

7. NATO sends in a “peace-keeping” force to protect Kiev and key parts of western Ukraine along the Dniepr.

8. By the end of 2025, the conflict freezes along the Dnieper.

From these eight steps, we unfortunately have seen #1, #2, and #5 come true, in some shape or form.

The European Union has also followed some of our worst-case predictions, including “Escalation of the war in Ukraine leading to a rearmament race in Europe” and the enactment of “Strict censorship laws silencing dissident, i.e., critics of the war and war efforts.” We fortunately did not see a regional war erupt in the Middle East, and thus we did not see another, more devastating energy crisis emerge, like our worst-case scenario warned. However, we are now seeking a repetition of this.

Based on the above, it is our unfortunate conclusion that the developments in 2025 followed a combination of our consensus (most likely) and pessimistic (worst-case) scenarios. This, unfortunately, provides support for our peak escalation hypothesis and the existence of the War Triad (formed by the military-industrial complex, the deep state, and the shadow world government or ‘group-over-groups’). This evidence naturally fed into our most likely scenario for 2026, and it also guides our best- and worst-case scenarios, to which we turn next.

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The optimistic scenario for 2026

We base our optimistic (best-case) scenario for 2026 on two key assumptions. The first one is that the War Triad loosens its grip on global developments in 2026, which implies that, at least during 2026, the peak escalation hypothesis does not hold. This creates a route for the politicians to enact policies that actually benefit their constituencies. Some will take this road, while some do not, because they have already submerged too deeply into corruption.

Here’s our optimistic (best-case) scenario for 2026.

• Ukraine, 1st scenario: Peace will be found for Ukraine and for the whole of Europe, which consists of:

  • Ukraine classified as a neutral state, with no NATO membership and no foreign troops on her soil, but with the ability to seek EU membership immediately.

    • The European Union has its own mutual defense clause, Article 42(7), which provides all security guarantees Ukraine needs.

  • NATO bases are dismantled and troops repatriated across the eastern states of Europe (former members of the Soviet Union), and the U.S. withdraws its troops from Finland, returning the bases leased to it in the DCA.

• Ukraine, 2nd (alternative) scenario: In this somewhat radical best-case scenario Russia conducts a massive decapitation (bombing) campaign pushing both the resources of the AFU and Ukrainian people to the brink.

  • Railway infrastructure is destroyed, crippling the AFU.

  • Heat and power generation in Ukraine is crippled.

  • The public mutiny forces President Zelenskyy to seek peace ASAP.

  • The Paris Declaration is torn, President Zelenskyy steps down, and the Ukrainian parliament appoints Oleksii Arestovych as the interim president.

  • Peace will be found in cooperation with Russia, President Trump’s administration, and the European Union, but with Russia’s terms.

• Iran and the U.S. reach an agreement on Iran’s nuclear program, leading to the easing of sanctions against Iran.

  • Iranian oil and gas start to flow freely into the markets, pushing prices lower.

  • President Trump publicly detaches the U.S. from all Israeli aggression, vowing to defend it if attacked, though.

    • Israel is forced to retreat fully from the Gaza Strip and return its control to Palestinian authorities.

    • A two-state solution will be negotiated.

• China and the U.S. reach an agreement over Taiwan, where the island becomes a neutral, non-militarized state.

• The U.S. allows for Venezuelans to decide their governance in an open and democratic election.

  • President Trump makes a public pledge that the CIA or any other U.S. intelligence apparatuses will not meddle with the elections.

  • The Kremlin and Beijing make similar pledges.

• Recession will arrive to the U.S. between Q2 and Q3.

  • President Trump announces that the White House will concentrate on cutting the deficit and makes it clear that a recession is what the U.S. economy needs.

  • The Federal Reserve keeps interest rates elevated during H1 to combat elevated inflation pressures, and starts a rapid cutting cycle during H2, when inflation pressures ease in the wake of an emerging recession.

  • Asset markets rise early in the year but then enter a bear market lasting the entirety of the year.

• Stress in the repo markets grows, but the Fed denounces a role of providing emergency liquidity through its Standing Repo Facility only.

• The issues in Private Credit will deepen in the wake of the recession, but credit funds will manage themselves without a collapse.

• The onset of the recession, financial market turbulence, and the growing stress in Private Credit will lead to some bank failures over the course of the year.

  • The Federal Reserve, the European Central Bank, and authorities on both sides of the Atlantic will manage bank failures on a case-by-case basis.

  • The third wave of the Global Financial Crisis raises its head but remains subdued due to credit funds managing their troubles and the measures (cautious actions) by authorities in China, Europe, and the U.S.

  • Recapitalizations of banks will be enacted.

• Both the Trump administration and European leaders announce programs to combat ballooning fiscal deficits.

  • During H1, European countries led by Germany announce slashing of promised increase in military spending in a response to the U.S. pulling away from Europe.

  • Yields of bonds react positively to the news and to the recession, removing most of the inflationary pressure, declining in the U.S. and in Europe. This creates fiscal space for sustaining the welfare state in Europe.

• Global leaders, also in China, announce that the time is ripe for a global recession. However, a strong recovery through private investments in AI and human capital starts to take form already at the end of the year.

  • Many firms realize that they have over-invested in artificial intelligence and start to invest in the human workforce again.

  • This policy change creates a new human-AI sector feeding into notable productivity growth, rapidly rising wages for both blue- and white-collar workers, increasing living standards, and declining income inequality.

• Gold prices, alongside many metal prices, rise steadily (but slowly) all through the year.

• Cryptos go through an early-year correction that wipes out a good amount of the remaining speculative excesses. Bitcoin and a few major protocols, which have (some) fundamental value, rise alongside gold as alternative stores of value against fiscal dominance and banking stress. Regulators in the U.S. and Europe clarify rules for stablecoins and tokenized assets, which allows banks and asset managers to start using blockchain rails for payments and settlement creating real value for them. By the end of 2026, cryptos are smaller, more regulated, and integrated into global financial plumbing instead of standing against it.

What needs to be noted here is that “loosening of the grip” of the War Triad can mostly come out of the general populace rejecting the path and logic they are forcing upon us. In our thinking, this would force them to a ‘strategic retreat,’ as they would not want to risk an exposure.

One can also imagine a “more optimistic” scenario, where the recession is avoided altogether with growing fiscal stimulus and rapid easing of the monetary policy. However, like we have warned for years (see, e.g., this and this), such a policy line cannot be considered as positive, because it will just increase the likelihood of an even bigger crisis (collapse) in the future. Hence, in our optimistic scenario, a global recession is allowed, also because it would clean the world economy from excess debt and malinvestments.

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The pessimistic scenario

In the worst-case scenario, we assume that the War Triad will tighten its grip on the world’s development during this year. This implies that the room for maneuver for politicians shrinks nearly to non-existence and that the peak escalation hypothesis, with its likely sinister aims, takes the central stage in all major geopolitical developments.

Our pessimistic (worst-case) scenario for 2026:

• Ukraine, 1st pessimistic scenario: A fragile peace is found for Ukraine.

  • European military hubs are established in Ukraine.

  • European and U.S. troops are set to monitor the line of ceasefire.

  • The Ukrainian military will be rearmed with the help of NATO.

  • These actions will pave the way for the continuation of the conflict in the future.

• Ukraine, 2nd pessimistic scenario: The war continues and starts to spread.

  • Russia turns down all peace proposals because they include either European troops on the ground or pervasive security guarantees issued by many European countries and the U.S.

  • Russia gradually widens its strikes to western parts of Ukraine, targeting supply routes of Western military gear into Ukraine.

  • The NATO-Kiev block grows desperate, leading them to target Russian leadership, use a dirty bomb, or conduct a major false flag attack on European soil against the European populace.

  • NATO enters the war directly.

  • Russia-NATO war erupts.

• Europe continues to rearm.

  • All major European nations announce major rearmament programs.

  • The EU (Commission) hijacks even more power from national states while enacting a major program aimed at issuing €1-2 trillion in debt to rebuild European military capacity (from the pessimistic scenario of 2025).

  • The EU begins turning into a federal Defense Union.

  • Censorship laws are enacted to silence dissidents of European origin, i.e., critics of the war and war efforts with citizenship in an EU member state.

• The Israel-Iran conflict flares up during the first months of the year, engulfing the continent.

  • Conflict deepens, combining the economic worst-case scenario and the worst-case scenario for the Iran-Israel war.

• A major energy shock emerges as a result, sending inflation to double digits by the end of the year.

• The U.S. keeps on providing weapons to Taiwan, which leads to China enacting an invasion of the island at the end of the year.

  • This creates a risk of existential escalation in the South China Sea in 2027.

• Central banks are forced to restart rate rises.

• The global economy enters a recession during Q2, which deepens into a depression by the end of the year.

• The issues in Private Credit will deepen in the wake of the recession.

  • Bankruptcies start to accelerate.

  • Stress in the repo markets will explode, forcing the Federal Reserve to enact a “true QE.” By the end of the year, it reaches the levels last seen during the Corona panic of 2020.

  • Bank stocks enter a bear market.

  • A trouble with a major U.S. lender emerges.

    • The Federal Reserve enacts a bailout, but it will be inefficient in calming the panic.

  • The third wave of the Global Financial Crisis emerges in full force during the summer and early fall.

• The global economy first falls into a recession during Q3, which rapidly deepens into a depression in the wake of the financial crisis.

• Fiscal crises emerge across the globe all through the year.

  • “Rattles” in the Treasury markets grow all through the year as the fiscal deficit in the U.S. grows uncontrollably.

  • European sovereign bond markets start to exhibit serious stress, which leads the European Central Bank to issue QE during H2.

  • During H2, a sovereign debt crisis engulfs the developing nations, with a deluge of governments either defaulting on their debts or seeking a bailout from the International Monetary Fund (IMF).

• The prices of gold and silver explode, with gold passing the $6000 per ounce mark.

• Financial sector issues first lead to a rapid increase in the price of Bitcoin, but it crashes by the year-end due to:

  • 1) Attacks towards the crypto industry by the authorities in their preparation for launch pilots of central bank digital currencies, CBDCs, during 2027.

  • 2) The sinister nature, or origins, of many cryptocurrencies rises to the limelight, creating mistrust in the sector in its entirety.

• The rapid development of AI leads to worrying discoveries about its nature and psychology. The “Terminator Scenario” starts to unveil.

It is, of course, possible to envisage even a darker scenario for 2026, but that would entail moving into developments we consider highly unlikely to occur. These include a deliberate nuclear weapon usage by a nuclear power. Like we have warned, such an extreme atrocity is within the realms of possibilities currently, but it is our take that all the leaders of major nuclear powers, that is, President Putin, President Trump, and President Xi Jinping, will go to great lengths to avoid the escalation of any conflict to a nuclear confrontation. However, this does not rule out the possibility of a rogue state developing a nuclear weapon or detonating, e.g., a ‘dirty bomb,’ like we note above. In other words, our (pessimistic) worst-case scenario for 2026 revolves around the deepening global escalation, without an existential event, and the emerging global economic crisis.

Likelihoods of scenarios

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1. The (updated) building blocks of the approaching Perfect Storm of the world economy.

2. An (updated) roadmap into the Perfect Storm.

In this second part of the Special Issue dealing with the approaching Perfect Storm, we update our view from the path of the world economy into the economic collapse we first envisaged in December 2017.1 In this report, we will present how we consider the crisis to proceed under a no-bailout scenario. In other words, we will present a scenario where we assume that central banks and governments will not try to stop the collapse but only to maintain credible monetary and fiscal policies.

We want to start with such a laissez-faire scenario because it helps to depict the likely ignition point and the path of the crisis. Currently, we consider the private credit sector the most likely point of ignition. We have detailed many of the reasons behind this assumption (see this, this, and this) and continue to deepen our analysis here. I have to emphasize that this report serves as a starting point, where we list the sections of the economy alongside the markets we see to push the “storm” into motion. Updates to this report will thus follow when the path ahead of us starts to open up.

Most notably, like we have seen over the course of the past 17 years (since the Great Financial Crisis), central bankers and government officials seem not to want the economy and financial markets to correct the financial excess they have created since the GFC. This, most likely, is because they would face a day of reckoning on their reckless policies. To account for this, we will be publishing a scenario detailing a bailout scenario, where we assume that central bankers and political leaders would try to stop the collapse.

Weekly Forecasts will take a holiday break for the next two weeks, which means that the follow-up scenario will be published some time in January. Remember also that our Christmas offer expires on the 31st.

Happy Holidays!

Tuomas

The building blocks

In December 2017, we noted that the coming “storm” would be caused by a combination of five factors, which we now update to these:

1. The ‘everything bubble.’

2. The zombification of the global economy.

3. The over-indebtedness of China.

4. The teetering banking sectors of Europe and the U.S.

5. The increasing meddling (panic) of the central banks.

6. The deepening issues in the U.S. private credit sector.

We can now assert that the everything bubble is much bigger than what it was in 2017 (or in 2000). Figure 1 presents the U.S. market capitalization to GDP ratio, also known as the Buffett Indicator.2 The indicator is currently sky-high.

While the market cap was around 135% of GDP in December 2017, it’s now at around 224% (more technical metrics also show a notable overvaluation of U.S. stock markets). From the site Long Term Trends, you can also check the public and private equities to GDP ratio, which is even more elevated than the market cap to GDP ratio (check also charts by Hussman Funds). Also, for example, the high-yield spreads are at all-time lows, indicating that prices of ‘junk bonds’ are at all-time highs. These indicators serve as stark evidence of the growing everything bubble.

We have written about the “zombie companies” many times. Tuomas presented arguably the most comprehensive account just little over a year ago, where he summarized the detrimental role zombie corporations hold in the economy:

Zombie companies are a massive burden for the economy. They restrict the entry of new, more productive companies, diminish job creation in the economy and lock capital to unproductive use. When capital is locked to unproductive firms, this stall the productivity growth of the whole economy. Zombie companies seek to survive, not to thrive. They hoard money and debt, but do not invest. Workers may keep their jobs, but also they are locked in unprofitable production.

In addition of effectively blocking the productivity growth of an economy, zombie corporations are also very likely to fail, when the availability of credit contracts. This usually occurs in a recession, which also tends to sap the demand of their products. In other words, we can expect mass corporate bankruptcies in the approaching recession, and this is not all.

During the past few years, it is likely that the private credit sector has been breeding zombies because of 1) increased inflow of funds seeking illiquid high-yield investments and because of the 2) likely inexperience of fund managers in corporate profitability assessment. The former has created a pressure to distribute loans also to companies with questionable profitability (including zombie companies), while the latter implies that the issue of the private credit sector providing lending to unprofitable companies may be systemic.3 We can assume that the trend of “zombie financing” has accelerated notably since 2024, when the lending of commercial banks to non-depositionary institutions started its rapid ascent, indicating both the rapid growth of the sector and banks becoming more and more involved in Private Credit. Therefore, the private credit sector is likely already holding a considerable share of risky loans, and this share is assumed to be growing rapidly currently, which will lead to a significant number of these loans becoming delinquent quickly when a recession arrives. Alas, the “zombie problem” is likely to be much more severe than what it was in December 2017.

China has been on our radar since early 2017, when we first understood A) her leading role in the world economy and B) the extreme indebtedness of her economy. The issues faced by China can be summarized with this figure.

Figure 2 shows that the “growth miracle” of China has been based on unsustainable growth of debt since the Great Financial Crisis. What probably occurred back then is that Beijing enacted a bailout of the Chinese economy (in 2009), and was unable to stop “bailing out”, as deleveraging of the Chinese economy would have caused a recession, or a collapse.4 Chinese Communist Party fears this, because it could challenge their rule. Beijing thus became entrapped to debt stimulus in the wake of GFC, but it is obvious that the trajectory depicted in Figure 2 can last for only so long. That said, Beijing has consistently surprised us with its ability to avert the unraveling of the Chinese economy on multiple occasions. Our August 2023 warning about the looming collapse of China serves as a testament to our failure. Essentially, we have been categorically wrong on the short- to medium-term ability of Beijing to keep pushing the economy forward, but this ability remains to be contested in a global crisis scenario, which is now approaching.

We don’t need to write much about the fragility of the European and U.S. banking sectors, as these issues already surfaced in September/October 2022 and in March 2023. However, it is possible, or even likely, that the third wave of the Global Financial Crisis does not emerge from the banking sector, but from Private Credit.

In addition to the risks posed by the private credit sector, we see the ‘everything bubble’ as another main problem. If it ‘pops,’ it will eat away most of the global financial wealth, causing a recession by itself. In The fraudulence of central bankers and the limits of their power, Tuomas listed the major market bailout operations conducted by central banks between 2008 and 2020. This is what we call the “panic of central bankers,” i.e., their inability to allow the markets to correct. Just last week, we got another bailout, this time a preemptive one, when the Federal Reserve restarted asset purchases, just 11 days later than it had ended them, to “maintain an ample level of reserves” in the financial system. Like Tuomas noted last week, this is utter nonsense. Effectively, the Federal Reserve is trying to tell us that close to $3 trillion of excess reserves is not enough for the U.S. banking system to operate properly.5 Right…

While the recent steep drop of reserves may have been the ‘spark’ that pushed the Fed to act, the “Not-QE” II, most likely, is a desperate attempt to fix the financial plumbing (repo markets) of the U.S. However, if the hypothesis Tuomas presented in the Is Private Credit the source of the stress in repo?, holds, this is unlikely to succeed, because stress is coming from firms and funds outside the repo. From the entry by Tuomas:

In other words, stress would be spreading to banks exposed to Private Credit, who want to access the SRF [Standing Repo Facility of the Fed] only as a last resort because using it shows a systemic stress. That is, even though the parties accessing it are classified (up to two years), the amounts drawn from the SRF are not. This means that other financial institutions can assume (or guess) which banks are using it based on their (rumored) financial health. Banks in trouble would want to avoid using the SRF, because it would indicate (repo counterparties would guess) that they are the ones unable to borrow from triparty repo with favorable rates, dampening the trust of other financial institutions in them even further.

Essentially the above hints that the stress in repo arises from the private credit sector, which means that the Fed does have the means to quell it. The only thing it can do is to flood the system with money and “hope” that the investment (credit) funds in trouble will be able to repair themselves. This assumption, along with its by-products, will serve as the foundation for our ‘roadmap’ that guides the global economy towards the Perfect Storm.

An updated roadmap to the Perfect Storm

It already now looks like the repo-market bailout by the Federal Reserve did not succeed. Liquidity injections through the Standing Repo Facility of the Federal Reserve have continued this week. We, of course, have to wait a bit longer to make any definite conclusions, but if the stress in the repo persists, it would bring more evidence that it is actually coming from the private credit sector and it is something the Federal Reserve cannot fix. This would imply that the Perfect Storm will hit this time. But how would the ‘storm’ proceed this time around?

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Our main assumption was that central banks will start their asset run-off programs (quantitative tightening, QT) in 2018, which will give rise to the first signs of the crisis. This forecast was realized with the QT of the Fed starting (in full force) in early 2018, followed by other major central banks over the course of the year, leading to serious market turbulence in late 2018. By early January 2019, the financial markets had drifted to the brink of collapse, which led to the infamous ‘pivot’ of the Federal Reserve (between January and March). Our assumption was that the crisis would intensify in 2019 due to the withdrawal of artificial central bank liquidity and China’s exhaustion. This assumption was realized in the repo crisis emerging in September 2019. It could have set the Perfect Storm in motion, but it was quelled by central banks (and Beijing).

What we failed to foresee in our path-breaking report was the ability, and willingness, of authorities in China and major central banks to enact yet another bailout of the financial system (we were naive to think that they would not). We naturally were also unable to foresee the emergence of Corona in early 2020 and the gargantuan fiscal and monetary stimulus that followed. These events resulted in the postponement of the onset of the Perfect Storm.

While our December 2017 assessment of a high likelihood (85%) of a market crash during 2018 proved accurate, our high likelihood (75%) of a banking crisis commencing was a significant overestimation. This is because predicting the timing of bank runs, even with a one-year margin, is very difficult. We faced this challenge again three years later. In 2020, we forecasted that a banking crisis would emerge in 2021, but it surfaced only in September 2022. The second wave of the Global Financial Crisis emerged in March 2023, but it was pushed back under the surface with authorities throwing a proverbial kitchen sink at it.

With this republication, we want to provide you an understanding of how an economic crisis can begin under the circumstances that have existed for many years. It is a road map, of sorts, which holds in many ways still. Next week, we will unveil an update on our projected path to the Perfect Storm.

I also unveil that we will be updating the structure of the Weekly Forecasts during January to serve our customers better. This year, the structure has been messy, and we want to clarify what we offer. I will write more on it in due course. I want to end with a reminder of our Christmas offer.

Tuomas

Introduction

• Global economic growth has accelerated while the imbalances behind the façade of this economic expansion continue to grow.

• The detrimental development over the past nine years is currently converging toward a “perfect storm” likely to engulf the global economy within two years.

• In this special report, we provide a roadmap for the upcoming crisis.

• The crisis is likely to start with a financial shock emanating from one of the overbought markets.

Eerie complacency has taken over the markets. Even though the debt stimulus of China (see Q-review 1/2017) and the pro-business policy of Donald Trump (see Q-review 4/2016) give a strong lift to the global economy, we are not moving in the right direction. Although the renewal of global growth is extremely welcome, the imbalance behind the façade is widening. In this sense, the above-mentioned drivers are a kind of Trojan horse. They have deceived the markets (investors) into thinking that the prosperous times will persist, but this is far from reality.

In this special report, we gather our analyses for the past six years and provide a roadmap for the next crisis. Because basically all the imbalances are converging to an increasing trend, the impending crisis will be the largest the world has seen since the 1930s. We call it a ‘perfect storm.’

The ‘perfect storm’ is a combination of five factors:

1. The ‘everything bubble’

2. The zombification of the global economy

3. The over-indebtedness of China

4. The teetering banking sector of Europe

5. The end of QE and the beginning of Quantitative Tightening (QT)

We address each in turn.

Bubbles, bubbles, bubbles

The single most important economic innovation of mankind has been the discovery of the market pricing mechanism, i.e., a system where the seller (producer or owner) and the buyer come together to discover the price for a product or service. Both agents try to optimize the offered price based on their budget limits and preferences and on the features (age, risk, etc.) of the product or service in question. The main point in the pricing mechanism is that both the seller and the buyer win. If not, another round of the price negotiations would be conducted to determine a more suitable price. This continuous loop of price negotiations creates the market mechanism, where the value of every service and product is discovered to optimize their allocation in the economy. Without the market price mechanism, the allocation of the resources calls for some centrally controlled mechanism, like socialism or another form of authoritarianism. These mechanisms are known not to work very well.

In the current financial markets, there is one major entity that does not have a budget limit and the only aim of which is to tweak the market prices to whatever direction it sees suitable. The central banks have, through their QE programs, effectively destroyed, or at least seriously damaged, the market mechanism and thus disrupted the allocation of financial capital. The central banks have, in essence, created their own version of a centrally controlled economy. There has never been such a monetary policy experiment in modern history.

Moreover, after 2009, the central banks have always run to the rescue in heavy market turbulence, which notably happened in 2008/2009, 2011,1 2012,2 2013,3 2015,4 and 2017.5 This has created an extraordinarily dangerous market environment, where the market-wide losses and risks have been socialized by the central banks. The market participants have adjusted to this low risk, thus attracting them to buy riskier (and higher-yielding) products and to leverage ever more (to gain sufficient profit from low-yielding products). In the words of Hyman Minsky, “stability is destabilizing.” However, it is obvious that this can not continue forever, as the central banks had to buy every larger correction in the asset prices, which would effectively transfer the private funds to the central banks and kill the capital markets.

Their swollen balance sheets (see Figure 1) reveal the perplexing extent of central bank-induced market manipulation. From the end of 2008 till October 2017, the balance sheets of the four largest central banks have grown by an astonishing 15 trillion dollars. This has created some strange and extreme imbalances in the financial markets. Figure 2 presents the sovereign bond yields of the US and Italy and the average yield of junk (high-yield) bonds in Europe and in the US. Several notions are in order. First and foremost, the figure directly implicates that the default probability of Italy and an average European junk-rated company is lower than that of the US government. This is, of course, just absurd. Secondly, the yields of the junk bonds have been in constant decline. The only jumps are the period between the second and third QE of the Fed and late 2015 and early 2016, when China had its mini-recession. Thirdly, after the China tremors, the European high yield started its relentless downward trend, pushed by the QE of the ECB.

What Figure 2 implies is that the market risks have been pushed into the far ends of the probability distribution, which has effectively made them invisible (see Q-review 1/2016). In addition, before all previous market peaks, some of the assets could be covered by holding the government bonds, whose value always rose when the stock markets fell and uncertainty increased. Now, the prices of all liquid financial asset classes are extremely high, indicating that there are no safe havens. Hence the “everything bubble.” Therefore, the risks, even if recognized, cannot be hedged in any simple way. This may have actually fed the frenzy in, e.g., the US stock markets.

We have warned about the risks of these unorthodox monetary policies several times (in Q-reviews: 2/2013, 2/2014, 1/2016, and 1/2017). In addition to distortions in the capital markets, the central banks have created a ‘zombie economy’ (see Q-reviews: 4/2013 and 3/2017). A zombie firm is defined as an entity that continues to operate only because it is offered some easy-term refunding. This is what zero or negative interest policies and QE-programs effectively do. They lower the cost of capital to unnatural levels. In such an environment, unprofitable companies are able to borrow and maintain their operations. The growing number of the zombie companies hinders productivity growth and thus diminishes the growth prospects of the economy (see Q-review 3/2017). Furthermore, as funding costs (interest rates) eventually increase, the zombie firms will collapse.

The other building blocks of a Perfect Storm

The economy of China has been on our watchlist since the very beginning (see Q-review 1/2012, only in Finnish). In early 2014, it reached a point where a cautious warning was warranted (see Q-review 1/2014, only in Finnish). In Q-review 4/2014, we warned about the possibility of a regime-altering economic crisis in China at some point in the future because of the massive scale of unprofitable investments. In March 2017 (see also Q-review 4/2016), we reported that China had been the sole source of growth for global private debt. In September 2017, we noted that the share of the private debt is over 500% of the annual GDP of China.

Because the extremely high debt levels combined with high quantities of unproductive investments suppress the effectiveness of any further debt stimulus, China faces a choice between two rather stark options (see Q-review 2/2017). The authorities need to choose whether to risk a serious slowdown now or to face a potential regime-altering crisis later. We are keen to bet for the former. Moreover, President Xi Jinping will probably like to have a booming economy by 2021, when China celebrates the 100th anniversary of the Communist Party. Keeping stimulus in place with these debt levels for another four years runs a risk of backfiring in a massive way. To stabilize a highly leveraged economy in four years, one needs to deleverage asap. This would remove a major support from the global economy (see Figure 3). We probably know whether this happens once the appointments and policy changes are made in the 19th National Congress during Q1 next year.

The banking sector of Europe has never recovered from the crash of 2008. This is because, unlike in the USA and in Iceland, basically all banks were saved in Europe during the crisis. Their balance sheets are still burdened by an unknown amount of toxic assets and unprofitable loans (see Q-review 1/2015 and Q-review 1/2017).

During this year, we saw what can be described as a final push of the central banks to lift the global markets. They have unleashed a massive money printing to elevate the prices of the bonds and equities as high as possible.6 The only problem is that this road is ending. The central bankers seem to have become aware of the monster they have created. It looks like the central bank of the US (Fed) actually started quantitative tightening (QT) in October, as the first central bank ever. The Fed tries to show that the unprecedented money-printing stimulus, QE, can be unwound and to build some ‘monetary policy muscles’ before the next recession. In some sense, the Fed’s balance sheet reduction is in an “autopilot” now, meaning that reversing the QT requires a new policy decision and a media frenzy that would follow it. If the Fed needs to pull back from QT, it would give a very negative signal on the economy and directly implicate that QE may actually be “forever.” We thus expect that QT reversal will be a “cold day in hell” event, meaning that it will be an absolute last resort for the Fed. Still, it should be noted that the Fed can temporarily stop the QT without any new decisions.

The BoJ and the Bank of England (BoE) have effectively tapered as well, meaning that their purchases have stopped. The People’s Bank of China (PBoC) still continues to increase its balance sheet, although its pace has somewhat diminished. PBoC does also conduct some “market calming” operations, like the $45 billion liquidity injections during the first weeks of November. The only central bank still “carrying the QE torch” is the ECB. However, it is closing on both the technical and political limits of its QE-program (see Q-review 1/2017 and Q-review 3/2017).

It is estimated that the global QE will turn into global QT during 2018. As QEs have been “highly effective” in raising bond and equity values,7 there is no doubt that QT will work the other way. Removing the excess liquidity is also likely to make the markets more reactive to geopolitical shocks.

A roadmap to the Perfect Storm

The world economy thus faces a pressure from five fronts. The global QT threatens to bring down the ‘everything bubble.’ The zero interest rates have created a fragile, ‘zombie-like’ global business sector, especially in Europe. China is pondering whether to face a serious slowdown now or a major crash later, and the European banking sector is still teetering on the edge of a failure.

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Mate

Q3 Balance sheet update on U.S. banks

In 2025Q3, the industry shows a clear downshift in momentum. Total assets still rose to roughly $25.11T. But the quarterly gain was only about $124.6B, far smaller than the stronger increases shown for Q1 (~$436.8B) and Q2 (~$450.8B).

There are mainly two reasons standing behind this smaller asset growth. Firstly, the core deposits shows that growth is still positive, but cooling materially, with the most recent gain at about $92.6B (0.58%).

Secondly, the following chart shows banks continuing to step back from the use of FHLB Advances(Federal Home Loan Bank). Advances fell from roughly $478.0B in Q2 to about $430.7B in Q3, pushing the FHLB/Assets ratio down to ~1.71%.

What fueled this asset growth?

Well, Net loans and leases did the heavy lifting at about +$157.8B. Trading assets rose roughly +$63.8B, and total securities added about +$59.0B. But these were offset by a notable drawdown in cash and balances (-$140.2B) and a decline in securities purchased under resale agreements (-$34.1B), with fed funds sold slightly lower and other assets modestly higher. Put together, Q3 looks like a quarter where banks kept lending, but didn’t meaningfully expand the balance sheet through faster deposit inflows or heavier wholesale funding.

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Due to unforeseen events, we are forced to cancel the publication of this week’s Weekly Forecasts. I needed to attend to a funeral outside Helsinki (taking two days) and Mate encountered a family emergency. Weekly Forecasts will return to a normal publication next week.

We apologize for any inconvenience,

Tuomas

P.s. Please note that our Christmas campaign will kick off with the publication of December Black Swan Outlook later today.

In my first entry into the series looking at the private credit sector of the U.S. financial system, I noted that:

Private Credit a practice, where private investment funds arrange and originate commercial loans (to businesses). Moreover, loans are not generally traded and are held in majority by the private investment fund (or companies) issuing them.

This sector has been growing rapidly during the past few years, but especially during the past year.

This week we take a deeper dive into the Private Credit through data. We detailed some of the growth of the sector in our October Black Swan Outlook, and now we continue to deepen our statistical understanding of it.

There are two main findings. First, major U.S. lenders are accumulating most of the risk of lending to non-depository financial institutions (NFDI), which includes the private credit sector. Secondly, there are spurts in lending to NFDIs matched by declines in commercial and industrial loans. This indicates that, especially during this year, large U.S. banks have, at times, aggressively transferred their business lending, and the risk associated with those loans, to the “shadow business lending” sector.

Tuomas

Bank lending to the NDFIs

Several exceptional features exist in the development of bank lending to non-depository financial institutions (NDFIs) in the U.S. The first feature is the significant increase observed in the lending series during the first week of 2025. Lending has also clearly accelerated since the start of the year.

Figure 1 shows that the loans to NDFI grew steadily from the beginning of 2015, with a small kink during the first Corona lockdowns. However, at the beginning of 2025, loans saw a massive jump upward, followed by a clear acceleration in the growth rate.1 In other words, there was a spur to growth, while the commercial and industrial loans issued recorded a near-matching decrease, shown in Figure 2.

So, in the first week of 2025, a significant event, a “kink”, occurred that changed both the levels and trajectory of loans to NFDI, resulting in a notable increase in its growth rate. There was something of a mirror image of this in the C&I lending, while their growth rate after the kink seems to have remained stagnant, like it has been since the second wave of the Global Financial Crisis in mid-March 2023. During the first week of January, loans to the NFIS skyrocketed by $239 billion, while C&I lending collapsed by $135 billion. Such a simultaneous movement at the beginning of a year hints at a change in the accounting.

This structural break in the first week of January also shows up in statistical analysis. Tests indicated that both loans to non-depository financial institutions and commercial and industrial (C&I) loans are I(1) nonstationary processes, indicating that they are driven by stochastic trends. Upon testing for cointegration, the test revealed that the two series do not share the same stochastic trend process. However, when we allowed a structural break to occur in their relationship during the first week of January, the Johansen Trace Test indicated that the two series are cointegrated. That is, the two series are (stationary) linear combinations of each other, and the break is an anomaly. Also, this hints that the break is artificial (i.e., accounting-related).

In other words, tests indicate that the loans to non-depository financial institutions and commercial and industrial loans share the same stochastic trend. What does this imply?

Two (or more) series sharing a stochastic trend indicates that they are driven by the same data-generating process.2 That is, the underlying (statistical) process is the same, i.e., there’s a common denominator driving the two series. While we cannot know with 100% certainty what this is (the very essence of stochasticity), we can deduce that it relates to the business sector of the U.S. economy. This is because commercial and industrial loans are directed to businesses, mostly to the SMEs (small and medium-sized enterprises), because big corporations tend to seek funding from the capital markets. The fact that loans to NDFI series share the same underlying (stochastic) statistical structure as C&I loans series thus indicates that the former are (also) driven by developments in the U.S. business sector. This is of course no surprise, because one of the main recipients of the NFDI lending is investment funds, which managed $300 billion already in 2010 (now they manage close to $2 trillion).3 We can thus conclude that loans to NFDI and thus private credit have been an essential and growing part of business lending in the U.S. since at least 2015 (the earliest date of our data). While at first glance this may not feel like a big deal, it actually is, which we’ll detail next.

The largest U.S. banks are accumulating the risk, yet again

What we want to understand next is into which banks this risk is accumulating. There we find a categorical difference between small and large banks in what comes to loans to NFDIs and in the risk accumulating in the private credit sector. Figure 3 presents the loans to NDFIs issued by large and small U.S. commercial banks.

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