That was that…cheerio 2025, welcome 2026

US President Donald Trump provided markets with a lot to think about in 2025. The imposition of trade tariffs was his most significant policy decision, but it is still not possible to fully assess what their impact has been. However, the global economy has been resilient and that has helped to deliver strong investment returns. What lies ahead are potential shifts in the sources of economic growth (e.g. more domestic demand in Europe, Japan and China), while the key question is whether the US’s recent slowdown in employment growth heralds a more serious economic soft patch. Rest assured, there will be noise. 

• Key macro themes – Stalling US employment; more interest rate cuts to come?
• Key market themes – can equity markets be more than just about artificial intelligence in 2026?

Inflation

Advanced economies’ inflation rates look to be settling in the 2% to 3% range. This may be uncomfortable for some central bankers who remain wedded to the pre-pandemic 2% norm, but there does not seem to be any real desire to push inflation lower. Markets are sanguine, with break-even inflation rates in inflation-linked bond markets between 2.0% and 2.5% in the US, around 2% in the Eurozone and 3.0% in the UK (based on the Retail Price Index and consistent with Consumer Price Index inflation of around 2.5%). Implicit is an expectation that inflation will ease a little more over the next year without interest rates having to be increased. Even where the inflation path is less clear – like with the effects of tariffs on US inflation – markets are taking the optimistic view.

The current US inflation picture has been muddied by the incomplete collection of consumer price data for the October and November period. But it looks as though both headline and core inflation could end the year well below 3.0% (November’s data showed a 2.7% inflation rate for headline CPI, October’s data has not been released). For the Eurozone, the year-end number should be around 2.0% and the better-than-expected UK data for November suggests 3.25%. For the US and the euro area, these numbers represent modest disinflation compared to the end of 2024. For the UK, last year’s Budget effects remain evident in the data but once they fall out of the year-on-year comparisons, there is scope for UK inflation to fall to the Bank of England’s 2% target in 2026.

Rates

Central bank rates are priced to settle at around 2.0% to 3.5%, close to what is generally thought of as neutral rates in many cases. That is somewhere just above 3.0% for the US, 2.0% for the Eurozone and 3.25% to 3.5% for the UK (with scope for rates to move even lower following encouraging inflation data recently and the Bank’s decision to cut rates on 3.75% on December 18th). There is a degree of convergence priced in. For example, the gap between the US Federal Reserve’s (Fed) rate and the Bank of Japan’s was 560 basis points (bp) at the height of the rate hiking cycle in 2022. Current market pricing has that gap at just 195bp by the end of next year. In their public comments, central bankers warn of inflation risks and that interest rates will have to go up again at some point – as per recent comments from European Central Bank (ECB) Executive Board member, Isabel Schnabel. However, there is not enough hawkishness to trigger a pivot in the path of monetary policy any time soon.

Equities

The outlook appears to be supportive for the continued solid performance of risk assets. On the equity side, earnings expectations remain strong. For the S&P 500, 12-month earnings-per-share growth is now expected to be 14.4% compared to 11.1% back in May. According to the Institutional Brokers' Estimate System - IBES - which aggregates equity analysts’ forecasts, growth estimates have risen for the US, Europe, Japan and emerging markets throughout 2025. If the rate outlook is stable, as suggested by markets, and multiples don’t change too much, then equity returns should match earnings growth expectations. After having concluded our usual series of meetings with sell-side economists and strategists last week, this concurs with what appears to be the consensus outlook.

Risks and returns

There are numerous risks to this comfortable outlook. Some observers think inflation could be tilted to the upside, which would make current break-even inflation rates in the bond market appear too low. Another, slightly longer-term argument is that there are upside risks to real interest rates. This comes from high government budget deficits, increased defence spending, and potential global rebalancing because of more protectionist economic policies (more of a tilt towards domestic demand in the large surplus areas like Europe, Japan, and China). High levels of investment spending on artificial intelligence (AI) and the related energy system build-out is also creating an increased demand for capital. Higher investment relative to available global savings should mean higher real yields. Higher real yields and higher inflation means higher nominal yields (steeper curves and higher long-term bond yields than current levels being a plausible scenario). However, it is worth noting that sentiment towards long-term government bonds has not got noticeably worse. Returns from the long end of government bond markets have been positive this year (5.2% for 10-year-plus US Treasuries).

Politics

Politics will again be important in 2026. At the global level a peaceful settlement to the Ukraine war would be positive. It also appears the US Administration has no appetite to ratchet up trade tensions. This is not out of any altruistic turn of events regarding international relations, nor in response to any evidence that tariffs are improving the US trade balance, but because of the mid-term elections. There has been much reporting about “affordability” which many have linked to the tariff impact on the prices of some items that carry more weight in the consumption baskets of lower income households (in November household goods inflation stood at more than 4.6%). The good news is that gasoline prices are easing, and the peak of housing cost inflation appears to have passed. Nevertheless, we should expect the White House to potentially announce policies that are designed to boost voter support in the run up to next November.

Deficits

The global picture is interesting. There is no evidence of global imbalances being reversed. Bloomberg data and the most recent Organisation for Economic Co-operation and Development forecasts put the US current account deficit at just over 4% of GDP. Japan’s surplus is accelerating while the euro area’s aggregate external surplus is more than 3% of GDP. Tariffs have complicated the picture on the US’s trade balance this year; it looks to be marginally improved relative to 2024’s deficit but is still significant. The pledges of trade and fixed investment inflows claimed by the US would, in any event, take time to impact on the balance of payments. For now, the US remains a major deficit country which will continue to absorb huge capital inflows into its debt and equity markets. The risk that foreign investors go on any kind of US asset buyers’ strike remains low, but at the margin a weaker dollar in 2026 is a possibility given the erosion of interest rate support for the greenback.