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Section 2: The economy and markets
Key points to know
Global growth should remain stronger than expected
Global economic growth has defied expectations for a tariff-induced slump this year. Throughout 2025, we viewed consensus expectations as overly bearish. After a sharp April drop following “Liberation Day” tariff announcements, consensus U.S. growth expectations have steadily rebounded to near their starting point. While the median recession risk forecast over the next 12 months has moderated slightly, it remains elevated at 30% – double the historical norm of 15%.
Tech investment has dominated headlines and clearly boosted U.S. growth. But consumers have performed equally well despite a softening labor market. Income growth remains healthy, and spending shows no signs of slowing. Lower gas prices have boosted disposable income, while fiscal and monetary policies have become more supportive.
We expect global growth to outperform expectations in the year ahead. In the U.S., euro area and UK, we forecast stronger-than-consensus growth. We also expect sequential improvements in Japan and emerging markets. China presents potential concern – we expect further deceleration, though at a gentle, nondisruptive pace.
Expansive fiscal policy could keep upward pressure on global inflation
Fiscal policy is loosening globally. U.S. budget deficits are historically wide despite low unemployment and strong growth. Using 1990 to 2015 as a template, U.S. fiscal deficits should be near zero today. Instead, they exceed 6% of GDP and are set to widen further. Similar dynamics prevail in Japan and Germany, while uncertainty dominates the UK and France outlooks.
On the plus side, this global fiscal expansion should support economic growth. A potent mix of fiscal initiatives hits in 2026 across multiple markets: tax cuts, increased defense spending, reshoring subsidies and the ongoing (if uneven) transition to renewable energy. But this combination risks keeping inflation well above central bank targets. Tariffs – one fiscal tool that actually raises revenues and improves deficits – carry their own inflationary impact. There is also risk of “crowding out,” where elevated deficits and interest rates divert capital from other worthwhile investments. For example, while U.S. tech hardware and software spending soared 15% year-over-year, the rest of business fixed investment actually contracted.
Interest rate and yield curve trends argue against extending duration
Given our outlook for strong growth and loose fiscal policy, we see limited scope for longer-duration assets to perform well in 2026. Our estimate of the global, GDP-weighted term premium recently touched 90 basis points – its highest since 2014. That increase has been driven by higher rates in the U.S., Germany, France, Japan and UK. We don’t expect major near-term fiscal policy changes, so this upward pressure should persist.
On monetary policy, we see little scope for excitement. We expect the U.S. Federal Reserve and Bank of England to continue cutting rates, but likely by less than markets currently price (Figure 1). Meanwhile, we expect the European Central Bank and Bank of Japan to hike rates by the end of 2026. Neither dynamic – market pricing disappointment or outright rate hikes – is likely to support duration.
Wildcard risks remain ever-present
Despite our positive macroeconomic outlook, persistent risks remain. Geopolitical turmoil could escalate, or new threats could emerge. On trade, we anticipate no fresh tariffs next year, but given 2025’s surprises, we would not rule out fresh shocks in 2026. The U.S. Supreme Court will likely rule on existing tariffs, potentially upsetting the existing framework. We believe other authorities could recreate the tariff regime on surer legal footing, but deployment may take time, and uncertainty could resurface.
Beyond tariffs, Jay Powell’s Fed Chair term ends in the spring. The White House will likely announce his replacement by early 2026, and markets are already pricing in a “new chair premium” – higher odds of a June rate cut than at preceding meetings. Questions about Fed independence could linger, maintaining downward pressure on the dollar.
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Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
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