Resilient growth and rising markets mask underlying structural tensions – the risks of a misstep are accumulating. We assess the balance for investors.
As we look ahead to 2026, the global economy is walking an ever-finer line. Growth has proven surprisingly durable, inflation has moderated (albeit unevenly), and markets have continued to climb. But beneath the surface imbalances are building. We believe the coming year will be defined by how successfully policymakers and investors can navigate the narrowing path.
Resilient progress, unexpected route
2025 broadly delivered what many expected: higher equities, gradual rate cuts and contained inflation. Yet it was not necessarily achieved in the way forecasters imagined. Corporate earnings growth in the US was less than expected but nonetheless resilient and particularly strong in technology, and durable consumer demand sustained growth – even as inflationary pressures persisted.
However, the divergence between regions has widened. Inflation sits near 2% in the eurozone, closer to 3% in the US and nearly at 4% in the UK. These differences reflect not only domestic policy approaches but also shifting global dynamics – most notably the principal story of 2025, the emergence of tariffs. As a result, the policy risks facing central banks have become more complex and the margin for error smaller.
Tariffs and inflation: a new kind of supply shock
We see today’s inflationary environment as fundamentally different to the post-Covid surge. Post pandemic, it was driven by excess demand and supply constraints as economies reopened; now it is shaped by supply constraints linked to trade policy and geopolitical uncertainty.
While some economists argue that tariffs are a one-off price adjustment, it is possible they are more likely to feed through to sustained inflationary pressure in 2026. Higher import costs tend to translate into higher wage demands and pricing power through the supply chain. Tariffs have not only raised costs directly, but their broader effect has been to disrupt supply chains and delay corporate decision-making. Companies initially absorbed some of these costs; we believe more pass‑through lies ahead, though not dollar-for‑dollar. In the US, where tariffs are most pronounced, inflation is proving sticky at around 3%. Conversely, Europe is seeing a disinflationary impulse as Chinese exports, directed away from the US, bring cheaper goods to Europe.
For investors this implies a more fragmented global inflation picture as we move forward – and therefore greater divergence in monetary policy and currency movements.
Central banks under pressure
Importantly, central banks continue to operate independently. However, that status is being tested. With President Trump signalling that he would prefer rates closer to 1% than 4%, and with the Chair of the Federal Reserve’s term ending in May 2026, the Federal Reserve (Fed) faces continued political scrutiny. A shift towards politically aligned appointments may compromise its long-term focus on price stability. Investors should remain vigilant and consider the implications for inflation expectations and asset pricing.
In addition, the government debt story is closer to becoming a market constraint (Figure 1). The US is on course to exceed 130% debt-to-GDP by the end of the decade, while France is projected to reach 118%, with its deficit stubbornly above 5% of GDP. When confidence erodes, repricing can be swift. The fact that 10-year yields in France exceed those of Italy and Spain – once the focus of concern during the euro crisis in 2009 – highlights how quickly investors can reassess financial risk, even within developed markets. Indeed, the UK’s mapped path to deficit reduction is, while ultimately stabilising, painful and problematic, illustrative of the difficulties in attempting to solve this problem. With increasing levels of government debt, it is possible that a funding scare in one major economy could raise the cost of borrowing across others.
Figure 1: Up, up and away
Government debt as a percentage of GDP
Source: Bloomberg as of 24 October 2025.
Therefore, we believe the risk of policy error – specifically, cutting rates too far too fast – is rising. Lowering short-term rates to ease financial strains could steepen yield curves sharply if bond investors lose confidence in inflation control, raising the five‑ to 10‑year funding cost and blunting any short‑rate relief. The experience of early 2025, when reciprocal tariffs briefly destabilised US bond markets, underlines that risk. In such an environment, with deficits high and pressures building on all sides, bond markets continue to act as a disciplining force – on governments and central banks alike.
With an expectation of a wider dispersion in growth, employment, inflation, and deficits across major economies in 2026, there are opportunities to diversify interest rate exposure and protect portfolios against equity drawdowns or a sharp deterioration in employment.
Global trade in transition
Tariffs and political uncertainty have altered the logic of globalisation. Companies that once expanded freely across geographies now face incentives to ‘friend-shore’ production or invest domestically. The absence of stability around trade rules has led many CEOs to simply delay investment decisions. We expect this uncertainty to persist and suspect that now tariffs have been introduced, unwinding them will be difficult.
As a result, emerging markets (EM) are feeling both headwinds and opportunities. A weaker US dollar has eased pressure on external debt, but the largest EM economies – China and India – face some of the largest tariff restrictions at 47% and 50% respectively. However, they both benefit from lower GDP per capita, which leaves ample runway for domestic growth. We believe selective exposure within EMs is warranted, with a focus on those benefitting from new supply-chain realignments and competitive currencies.
AI and energy: Themes in motion
The rapid advance of artificial intelligence (AI) is another topic dominating discourse, corporate strategy and market sentiment. We believe AI investment remains at the early-adoption stage – marked by extraordinary potential and clear signs of fiscal excess. Circularity is a concern with firms investing in their own suppliers and partners, blurring financial exposures and creating dependencies. This is workable when there is momentum, fragile when there isn’t. Our credit analysts are scrutinising such structures closely. There are echoes of the dot.com boom of the early 2000s, with some companies generating immense cashflows from selling the ‘picks and shovels’ of AI, while others spend heavily in the hope of future rewards. Well-capitalised businesses are better placed to fund this long gestation period.
Figure 2: Energy – changing regional variations
Global investment in the energy transition around the world, 2004-2024
Source: IEA/BloombergNEF Energy Transition Trends, 2025. EMEA = Europe, the Middle East and Africa; APAC = Asia Pacific.
Three-dimensional investment thinking
After another strong year for equities, valuations – particularly in the US – leave less margin for error. Market reactions to geopolitical shocks and tariff announcements have shown how quickly corrections can occur and reverse. But if we were to see a downturn alongside weaker growth or rising unemployment, the rebound might not be so swift or profound.
Diversification, therefore, is non-negotiable. Investors should think in three dimensions: across asset classes (equities, credit and alternatives); across regions (the US, Europe and EMs); and across themes (AI, fiscal resilience, the energy transition, etc). Credit markets could provide early indications of shifting dynamics, highlighting any increased differentiation between higher and lower quality borrowers. Private equity, meanwhile, could face headwinds from higher borrowing costs and tighter liquidity.
The bottom line
The global economy enters 2026 in reasonable health, but the risks of a misstep are accumulating. Inflation remains sticky and uneven, fiscal deficits are uncomfortably high and seemingly without solution, and the geopolitical framework continues to creak. For policy makers and investors alike, the balance between caution and optimism has rarely been so delicate.
We believe driving portfolio growth in this environment will come from patience, discipline, diversification and selectivity – with an active approach best-placed to recognise where change creates opportunity and exuberance masks fragility. The path is narrow, but it still offers a route to positive outcomes.
All data is Bloomberg as of 31 October 2025 unless otherwise noted.
