2026 Outlook: Smooth Sailing Ahead?
The year-ahead is full of major events, but also a growing set of risks that will require careful navigation, particularly around concentrated risk market valuations and weak labor markets.
An unfettered optimism, and a clear harmony in consensus views, calls for healthy skepticism. If there is a 1st half bounce in economic activity, it may lead to false hope if growth ultimately proves unsustainable as the year progresses.
Macro
- Baseline Economic Scenario: GDP drags along at or around potential (~1.8-2%), being weighed down by slow population growth, tariffs, and weak aggregate demand (AI investment and wealth effect spending no longer underpin growth), but fiscal thrust and World Cup fever may boost H1. The labor market continues to weaken with U/R trending toward 5% and with slow jobs growth restraining aggregate income & spending growth. Meanwhile, lagged housing disinflation and softer wage growth to largely offset tariff effects, pulling inflation down toward 2.5% or below.
Markets
- Rates & Fed Forecast: Given our bearish leaning view, we believe that the Fed will cut 3-4 times. Yet, if H1 is stronger, driving rates higher, we’d buy the dip. Our end of quarter estimates for the 10Y UST in H1 are close to our 3.75%-4.375% initial range view. We see cuts moving the whole curve (outside of 30s) sub the 4% level with 3.5% resistance for 10s.
- Credit Spreads: If rates ratchet lower as we expect, IG credit will start to lose the benefit of all-in yields. At this stage, all spread products are outside our fair-value ranges and have limited upside from spread compression, meanwhile as rates decline credit will widen from here. We expect IG to eventually move towards the top of our 80-100bp base range. In HY, it will come down to stocks and private credit pressures. We think HY spread tightening is near complete.
- Mortgage Spreads: MBS basis has already witnessed a fair amount of tightening as rate vol declined in 2025. However given our view on rates, we still like mortgages for carry and would add on dips whenever the basis widens vs USTs.
- Risk Markets: The stock market is playing a disproportionate role in both capital markets and wealth effect driven spending in the real economy. We are likely living through another bubble period that could lead to acute tightening of financial conditions if valuations were to normalize quickly. We argue for caution and extreme vigilance at this stage.
Please download the PDF (see link above) for the Outlook Report with supporting charts and forecasts on page 17…