Part 1 – The Headlines: Papering Over the Cracks
- 2025 was more resilient than expected as global liquidity recovered, led by central bank pivots and easing trade tensions. Yet liquidity has struggled to translate into real economic growth, creating a divergence with financial markets. Whether this divergence persists will be the key question for the 2026 outlook.
- Beneath the surface, most countries face a shared vulnerability of a worsening labor market. This, along with rising interest expenses, is limiting governments’ fiscal space and pushing them to adopt “creative” policies, leaning towards populist and protectionist directions.
- Persistent inflation, rising budget deficits, and geopolitical instability are collectively pushing long-term government bond yields higher across the globe. The shift to issuing bonds with shorter tenors has become inevitable, but it carries refinancing risk if the environment deteriorates. All of this makes the economic growth recovery in 2026 still quite fragile.
Part 2 – US & Rates: The K-Shaped Divide
- The K-shaped recovery in the US is intensifying, with wage gains for top earners outpacing those for lower-income households, exacerbating income disparity. This growing divide is further fueled by persistent inflation, which disproportionately impacts lower-income families, while the upper class has so far been protected by the wealth effect from rising paper asset prices.
- The recent tax cuts from the One Big Beautiful Bill Act (OBBBA) have led to concerns about a deepening budget deficit as the revenue from tariffs fails to offset the fiscal costs. As political pressures mount, particularly with Trump's declining approval ratings, there may be a push for even larger tax cuts, complicating the fiscal landscape.
- Although the Fed is likely to lower its short-term policy rate, US long-term bond yields are expected to remain high, and this is strongly correlated with lending rates such as mortgages. The government’s efforts to bypass this correlation through supply-side policies (such as capping lending rates or buying mortgage bonds) will still be constrained by the narrative of demand and the risk preferences of banks.
Part 3 – China & Commodity: Challenging Rebalancing
- China’s economy is sustained not by efficiency but by massive, state-supported production that has led to the rise of unprofitable “zombie companies.” This vast overcapacity creates a major disinflationary force globally as China exports goods at low prices.
- China is facing a structural crisis, including a declining population and weak consumer confidence, which fundamentally constrains its long-term growth potential. Unable to stimulate domestic demand, the government is forced to double down on external markets, pushing trade surpluses and outward investment higher.
- China’s continued industrial output will create sustained demand for commodities, setting up a strong outlook for metals that are crucial for the digital and green transitions. The outlook for other commodities is mixed, as the energy market appears bearish while agriculture faces significant risks from worsening weather patterns.
Part 4 – Financialization: The Cost of a Reversal
- A rate cut is expected to push the stock market higher, as the market is now hyper-sensitive to Fed rate expectations, a phenomenon that did not exist until recently. This disconnection from fundamental value is not confined to stocks but is also seen in other assets, like gold.
- Financial markets have dramatically outpaced the real economy. Even within the real economy, CAPEX is concentrated in AI, while companies are increasingly favoring share buybacks over long-term investment.
- This condition is unlikely to persist. History shows that such extreme valuations result in low long-term returns. The rebalancing process need not be a sudden ‘pop’ but could be a prolonged stagnation. The end result, however, is clear: capital will eventually return to the real economy, likely at the expense of the financial market (with the risk of a negative wealth effect).
