After growing at an above-trend pace over the previous two quarters, global economic activity appears to have decelerated in the final quarter of the year 2025, led by a slowdown in China.
Nonetheless, the global economy – and particularly the United States – has proved more resilient than many feared in the aftermath of President Trump’s ‘Liberation Day’ tariff announcements in early April. While the immediate impact of those measures weighed on confidence, activity has held up better than expected, and the balance of evidence points toward a reacceleration in growth through the first half of 2026. This outlook reflects a combination of front-loaded fiscal stimulus (government spending measures) in the US, the rollout of German-led defence and infrastructure spending in Europe, and further targeted fiscal and monetary easing from the Chinese authorities. Taken together, these forces should support a renewed upswing in global growth during 2026.
There is now growing evidence that the US labour market is losing some of its earlier strength.
Encouragingly, inflation data over recent months have generally been lower than expected, confounding those who expected a broad-based, tariff-induced increase in price levels. This benign inflation backdrop has contributed to what can best be described as a ‘Goldilocks’ macroeconomic environment, providing a clear tailwind for risk assets like equities, with global equities delivering above-average returns. This reflects a combination of easing financial conditions, improving earnings expectations and fading near-term policy headwinds. More fundamentally, recent developments underline a broader shift in the way economic and market outcomes are determined. Increasingly, it is policy – fiscal, monetary and regulatory – that drives growth, inflation and asset prices, rather than the traditional feedback loop from economic fundamentals to policy responses. In this environment, successful investing depends less on forecasting the economic cycle in isolation and more on understanding how policy choices will evolve and interact in the quarters ahead.
The policy-driven nature of the current cycle was clearly illustrated in the United States, where a government shutdown in October and November disrupted the production and dissemination of official economic data. With little reliable data released until late November, policymakers and market participants were forced to navigate an unusually ‘noisy’ information environment. These effects complicate interpretation but do not alter the broader message that US economic momentum, while cooling, remains intact.
There is now growing evidence that the US labour market is losing some of its earlier strength. Hiring has slowed meaningfully over the course of the year, yet layoffs have not risen significantly. This ‘no hire, no fire’ dynamic matters because it suggests the economy could decelerate without triggering a sharp increase in unemployment. At the same time, a different and more structural scenario is also emerging, in which trend-like growth could coexist with gradually rising unemployment, as artificial intelligence displaces certain categories of labour. Against this uncertain backdrop, and with inflation still somewhat above target, the US Federal Reserve (‘Fed’) chose to cut interest rates by 25 basis points at each policy meeting during the quarter, bringing the Fed Funds target range to 3.50–3.75 per cent.
Outside the United States, the dominant theme has been divergence in monetary policy. The European Central Bank ended 2025 with policy rates at 2 per cent, with officials increasingly confident that inflation is close to target and that restrictive settings are no longer required. Meanwhile, the Bank of Japan continued its slow and deliberate exit from ultra-loose policy, raising rates by a further 25 basis points to 0.75 per cent.
The most important variable for investors is likely to be the pace and extent of further Federal Reserve easing.
Financial conditions have also offered reminders that calm markets do not necessarily imply an absence of underlying stress. On December 31st, usage of the New York Fed’s Standing Repo Facility (which facilitates overnight borrowing by financial institutions) reached a record high, signalling year end balance sheet constraints and short-term funding pressures despite benign surface conditions. In response, the Fed has quietly introduced a new tool – Reserve Management Purchases – which closely resembles a form of targeted quantitative easing (i.e., monetary stimulus). This additional liquidity backstop could prove supportive for markets in the months ahead, reinforcing the perception that policymakers remain willing to intervene to smooth financial conditions.
Looking over the balance of 2026, the most important variable for investors is likely to be the pace and extent of further Federal Reserve easing. If inflation continues to improve and the labour market remains in a ‘cooling but stable’ zone, gradual additional interest rate cuts should support both bonds and equities, albeit with intermittent volatility. The principal risk to this outlook would be a renewed rise in inflation, whether driven by policy shifts or supply side shocks, which could force the Fed to pause earlier than expected. At the same time, growing global policy divergence – particularly between a normalising Japan and an easing bias in the US – raises the importance of currency movements and cross border capital flows, after several years of unusually synchronised monetary policy.
For bond investors, higher starting yields mean that income can once again account for a meaningful share of total returns. However, recent experience is a reminder that long duration bonds remain vulnerable to shifts in inflation expectations, fiscal concerns and term premia (i.e., the excess return that investors expect to receive for holding longer-dated bonds compared to shorter duration bonds). Corporate bonds continue to look attractive, while defaults remain contained, but the narrow yield compared to government bonds means that corporate bonds would be more vulnerable if the labour market deteriorates more sharply and layoffs begin to rise.
Against this backdrop, global equities appear well positioned for a constructive 2026, and we expect double digit returns across both developed and emerging markets. This optimism is underpinned by broadening earnings growth, easing interest rates and fading policy headwinds. The United States and Asia remain the primary engines of global expansion, driven by an AI-led investment cycle that is boosting capital spending and profitability. While this strength is spreading across regions and sectors, the global economy retains a K shaped profile (i.e., a growing wealth divide between the highest and lowest earners), creating clear winners and losers and fuelling populist pressures and unorthodox policy responses that can generate bouts of volatility.
In the US, economic conditions and policy support are likely to align. Our base case assumes the Federal Reserve cuts interest rates to around 3 per cent by year end, with scope for deeper easing if political developments encourage a more dovish tilt (i.e. one that prioritises economic growth over maintaining low inflation). A Trump-led effort to reshape the Federal Open Market Committee could amplify this trend, particularly if personnel changes embolden the administration to exert greater influence over monetary policy ahead of the November midterm elections. In this context, a full year S&P 500 return of around 10 per cent appears reasonable, with upside potential if inflation continues to soften, albeit offset for non-US investors by a weaker dollar.
Global equities appear well positioned for a constructive 2026, and we expect double‑digit returns.
Corporate profit margins have scope to expand modestly from already elevated levels, supported by evidence that AI adoption is improving productivity. Earnings growth in developed markets is expected to run in the low to mid teens, consistent with current valuations. While a relatively small group of AI leaders continues to dominate index performance, investment is spreading more broadly, and cash returns to shareholders should remain robust. From a portfolio perspective, this favours high quality AI beneficiaries and enablers, complemented by selective exposure to banks and pharmaceuticals, with small cap and low volatility strategies providing diversification in a more aggressive easing cycle.
Europe looks better positioned than at any point in recent years. Credit impulses are turning positive and fiscal programmes are being implemented, with earnings growth expected to match that of the US. Attractive valuations and cautious investor positioning create scope for returns to be better than expected, particularly in core markets such as Germany and France, as defence and infrastructure spending accelerates. UK equities remain deeply discounted relative to global peers and offer a defensive sector mix well suited to an uncertain geopolitical backdrop.
Japan’s outlook is anchored in policy continuity and reform, with governance changes encouraging improved capital efficiency, higher wages and rising shareholder returns. Emerging markets should benefit from falling local rates, stronger earnings growth and improved governance, with Asia particularly well placed to attract capital in a weaker dollar environment.
This broadly positive outlook could be derailed if supportive liquidity and interest rate cycles ended abruptly, most plausibly through a sharp and sustained rise in the oil price on further Middle East conflict, which drives up long-term bond yields. Barring such a shock, however, policy support appears set to remain in place, and we are cautiously optimistic that resilience can once again carry the global economy forward in the rest of 2026.
