A Preview of 2026: Five Key Themes

For all the focus on corporate capital expenditures, fiscal activity and other issues, consumers continue to drive global growth. While reported on a lag, domestic real disposable income (i.e., average household earnings net of inflation and taxes) has been positive every month but one since inflation peaked in the summer of 2022, suggesting that the average consumer is keeping ahead of inflation. However, averages do not provide a complete picture; consumers are not a monolithic entity but should, rather, be evaluated across cohorts such as income, age, industry and other variables. As our economics team asserts, the “K-shaped” economy persists and is characterized by a divergence in strength between higher-income consumers and lower-income consumers who are disproportionately impacted by inflation.

Looking across macroeconomic data, corporate earnings, spending trends and other resources suggests that, for now, we should expect domestic consumers to remain in a “grind-it-out” mode, with slight positive momentum. Chinese consumer activity remains subdued while Japan’s demographic challenges have been offset by modest inflation impulses (more on that below), and European spending trends remain lackluster. Trade policy overhangs, consumer overreliance on credit and artificial intelligence’s labor-market impact remain key risks, but we continue to see a “muddle-through” environment for consumer activity as we approach the New Year.

Central bank policy continues to have a significant capital-market impact, with the United States remaining the key policy setter. The Federal Reserve has three mandates; maintain price stability, promote maximum employment and pursue moderate long-term interest rates. This summer’s Jackson Hole Economic Policy Symposium marked an important U.S. monetary policy transition. Prior to this event, Fed Chair Jay Powell and his colleagues emphasized price stability, or inflation, as the primary risk, downplaying unemployment and long-term interest rate concerns.

However, during his speech, Powell surprised markets by emphasizing labor-market risks, noting that “while the labor market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests that downside risks to employment are rising.”¹ His assertion has proved prescient: With this week’s delayed jobs report, unemployment has risen from 4.2% at the time of the Jackson Hole speech to 4.6% today. These are still historically low numbers, but they are trending in the wrong direction. Inflation remains a risk, although consensus economist expectations plus those of the Fed suggest moderation over the next two years, with U.S. inflation projections still disproportionately higher than most of its major global economic peers.

With trade policies, the fate of U.S. tariff legal standing with the Supreme Court and other variables clouding CFO spending plans, we anticipate the Fed will remain more concerned about labor-market weakness than inflation, and will hence retain a bias towards cutting rates. Recognizing the pending change in Fed leadership, the interplay between new committee dynamics, inflation data and labor market trends will remain key focal points for us in 2026.

Three characteristics are shaping bond markets as we approach 2026: Nominal (non-inflation adjusted) yields are higher than their 20-year trend across longer-maturity bonds, credit spreads (the extra compensation investors require for investing in non-government issued bonds) are extremely low, and global defaults (bond issuers failing to meet financial obligations, including missing an interest payment) are below longer-term averages. These dynamics may change over the coming year, and we will keep you posted on our observations as the year unfolds.

While many readers may recall historical periods when interest rates were meaningfully higher, the 10-year U.S. Treasury bond yield sits at levels not seen since 2008. For nearly 18 years, investors, lenders and borrowers have lived in a world of sub-5% 10-year Treasury yields. And despite this year’s trade policy and inflationary issues, this has remained a durable ceiling. Although we anticipate inflation to abate, the upcoming change in Fed leadership, the gap between tariff rates and actual collections, and the risk of a widening fiscal gap could present a test to the 5% ceiling on the 10-year Treasury yield. A breach above that level is not our base case, but we have to respect upside risks to yields from levels we have grown accustomed to. This week’s rather benign Consumer Price Index (CPI) report — albeit with some statistical gaps due to the government shutdown — was not met with the higher bond price/lower bond yield reaction that conventional thinking would suggest, leaving us to continue to monitor bond auction activity to gauge changes in sentiment.

Low credit spreads and low default rates are interconnected concepts that are a function of corporate health, issuance trends and general economic activity. Again, while we anticipate interest rates to remain more rangebound in the near term, risks that bond yields rise or that certain industries demonstrate challenged fundamentals can impact a still-constructive credit backdrop. Similarly, for our taxable portfolios, gauging municipal bond market issuance and state budget health remain priorities for us in 2026. 

Perhaps the most cited equity market narrative for 2025 has been the more narrow leadership trend across major indices. To date, only three of the S&P 500’s 11 major sectors have outperformed the index’s total return. Narrow leadership has remained a persistent theme not just this year but also in 2024, when four sectors outperformed the index, and in 2023, when only three sectors outperformed. Two sectors in particular — communication services (which includes internet and media companies) and information technology (which includes software, hardware and semiconductor companies) — have dominated over the past three years and are up a cumulative 181% and 160%, respectively.

Markets discount future outcomes today, and hype around artificial intelligence applications and further infrastructure build-out surrounds market sentiment. We are watching for both overextrapolation of AI applications and overbuild risk, but we have been encouraged that markets have not provided all companies with blank checks for capital expenditures. We anticipate that 2026 will be a year when companies will need to stand and deliver on return-on-equity or return-on-capital-employed metrics for their AI spend, and market differentiation between winners and losers will likely become more pronounced. We are also encouraged that the financial services and industrials sectors have seen some positive momentum over the past three years, albeit well below the pace of index-leading sectors.

¹ Remarks by Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System, at “Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy,” an economic symposium sponsored by the Federal Reserve Bank of Kansas City. August 22, 2025. https://www.federalreserve.gov/newsevents/speech/files/powell20250822.pdf. Accessed 19 December 2025.