Weekly Market Update: Great expectations

Improving macroeconomic expectations

The US economy has weathered external shocks throughout 2025 and expectations for 2026 have improved substantially - the latest Bloomberg Consensus GDP estimate stands at 2.4% (see Exhibit 1).

A key factor behind the economy’s resilience is artificial intelligence, which has markedly helped to boost investments over the past 12 months. Furthermore, a repeat of the productivity shock seen in the late 1990s - eventually leading to market returns of more than 20% between 1995 and 1999 - is not an unlikely scenario. Though this period was of course followed by the bursting of the dotcom bubble.

The current cycle has also been accompanied by what sceptics would see as unnecessary monetary policy accommodation, which has supported equity performance despite already relatively high valuations. 

AI-driven inflation?

While the inflation picture might still be somewhat blurred by 2025’s US government shutdown, investors are starting to ask legitimate questions about the inflationary impact of AI.

Water, electricity, nuclear energy and rare earths are key inputs to the new technology. Rare earths in particular have rallied by some 135% over 12 months and are quickly assuming a strategic role, probably as much as oil in the 1970s. Going forward we might witness AI-related inflation pressures across several sectors of the economy.

Some measures point to US inflation being above the Federal Reserve’s 2% target in the medium term, thereby confirming consensus forecasts and casting doubts about the convergence process. Interestingly, analysis provided by the San Francisco Fed supports the idea that current inflation is mainly demand-driven and might lend itself to better control by standard monetary policy tools. 

Bullish sentiment and positioning

According to one Bank of America survey, a ‘no landing’ i.e. above trend economic growth, is the most probable scenario for the US economy 12 months down the road.¹ As such, return expectations for the main equity indices are all skewed toward the upside.

In fact, according to surveys, Wall Street strategists do not expect the S&P 500 to deliver a negative performance in 2026 and this comes on top of a continued risk accumulation in institutional and retail portfolios, both in the US and in the Eurozone.

Financial conditions reflect these portfolio trends, thus signalling a rather buoyant environment for financial markets. Nonetheless, extremely skewed positioning is always a factor to consider in the context of tactical asset allocation, as minor shocks could easily be amplified and affect performance even in the medium term. 

Quo vadis Fed?

Based on market expectations, the Fed is expected to cut interest rates by a total of 45 basis points in 2026. However, adding monetary policy accommodation to an already resilient economy which is supported by expansionary financial conditions might seem a risk in terms of future inflation.

The Fed will continue to take stock of incoming information, as well as of the evolving monetary policy stance. In fact, the actual stance might be close to a neutral position – i.e. neither stimulating nor restraining the business cycle.

Currently, the Fed Funds target rate is consistent with measures frequently used to assess so-called ‘neutral interest rates’. The next milestone is set for mid-March, when the Fed releases its Summary of Economic Projections and the market is not discounting a rate cut at that particular meeting. 

Duration vs. credit

Duration has so far had a disappointing start to the year, driven partly by dynamics in the Japanese government bond market. For example, US high yield bonds have outperformed US Treasuries by 0.7% since the start of the year. Japanese investors have a large footprint on international bond markets.

Looking forward, their appetite for non-domestic bond exposure might increasingly reflect the narrowing spreads - yield difference - between JGBs and Treasuries. Of course, a decrease in Japanese demand for Treasuries needs to be offset by an increase in somebody else’s demand, therefore preventing a sudden re-pricing of fixed income assets.

From an investor’s point of view, the choice between longer-duration assets and a higher income strategy comes down to the risk-neutral valuation of the slope of the curve versus the level of credit spreads. While credit spreads are hovering close to all-time lows, the yield curve is still relatively flat and unable to offer a valuable alternative to the corporate world. Moreover, the qualitative improvement in credit-index composition hasn’t gone unnoticed: The sub-investment grade (BB) bucket now accounts for over 60% of the global high yield universe, up from 35%, 20 years ago.

(Source of performance data – Bloomberg)