What does 2026 hold for macro and markets?

Paul Diggle

Hello and welcome to Macro Bytes, the economics and politics podcast from Aberdeen Investments. My name is Paul Diggle, Chief Economist at Aberdeen. This is going to be our last episode of 2025 and I've asked each member of the economic research team here at Aberdeen for their key question on the year ahead. So enjoy. 

Jon Butcher

Hello, I'm Jon Butcher, Senior US Economist, and my question is: will stronger US economic growth in 2026 lead to a labour market rebound? We're expecting the pace of economic growth in the US to pick up next year, with GDP expanding by a slightly above consensus 2.2%, but will that translate into a stronger labour market? The doubt comes from the fact the US labour market has been weak over the past six months or so, with low levels of job creation and an unemployment rate that's been creeping higher. But despite this, the US economy has been growing at a solid pace, with both consumer spending and business investment doing well. We do see the labour market improving in 2026, but to answer why this is the case, we also need to understand why it’s diverged in the first place from the economic performance. Now one of the key reasons is that the labour market performance has been split between high and low earners and between large and small businesses. The uncertainty that arose from President Trump's Liberation Day tariffs disproportionately impacted small businesses who reduced headcounts or delayed hiring as a result. This also hit lower income earners more, who have been seeing less wage growth and an underperformance relative to high income households. And those wealthier households have also benefited more from the stock market rally due to higher equity ownership. This in turn has fed through to strong consumer spending from high income households and supported economic growth. Essentially, this is the ‘K-shaped economy’ that's been attracting a lot of attention. One other factor that's been contributing to the split between jobs and economic performance has been strong AI-related investment, something that is capital intensive but not particularly labour intensive. Now, whether these factors persist next year is key to determining whether the labour market rebounds in 2026, and our answer is a little bit mixed. We do see the expansion in AI investment continuing through 2026, supporting economic growth. But the recent easing in monetary conditions should also feed through into a more broad-based business investment story, supporting job creation. Peak tariff uncertainty also looks like it has passed, and a decrease in risk sentiment should feed through into improved hiring from small businesses, in particular, quite rapidly. But, barring a collapse in equity markets, prospects for wealthier and higher income households will still likely be better, at least through the first half of next year. And finally, in addition, improving productivity gains could limit the rebound in hiring in some sectors more than others. So, in short, stronger GDP growth in 2026 will help stabilise the labour market, but don't expect a boom. We see the unemployment rate coming down from around 4.5% at the start of the year to 4.2% at year end. Essentially, steady improvement but not a hiring frenzy.

Luke Bartholomew

Hello, this is Luke Bartholomew, and a key question I'll be watching for 2026 is what happens to policy at the US Federal Reserve under a new Chair? Now, Jay Powell's term as Chair expires in May, and it's not yet clear whether he'll also be stepping down from the Board of Governors at that point, creating another vacant seat for the Trump administration to fill. But one thing is for sure, that is he will be replaced by a Trump appointee as Chair. Now, as we record this in mid-December, we're still awaiting the announcement from the administration as to who their nominee will be. This could be coming in any day now. But as things stand, betting markets are pretty clear that the favourite is Kevin Hassett, currently the director of Trump's National Economic Council. Now, Hassett is an interesting character. On the one hand, he has a long history as a credible, albeit clearly partisan, conservative policy economist. On the other hand, some of his recent comments and closeness to Trump have led to concerns about his independence. And that really matters because Trump has made very clear what he wants to happen to interest rates. That is, he wants interest rates to be cut significantly. And if the perception develops that Hassett or indeed any other Fed Chair is cutting interest rates because that's what the White House wants, rather than that's what the economy needs, then that will lead to serious questions about the Fed's credibility and independence. You might expect inflation expectations to start increasing significantly in that environment, and paradoxically, it could also lead to a big increase in long-term government borrowing costs, exactly the opposite of what the administration is trying to achieve. And in turn, that could lead to more pressure for more intervention, perhaps capping long-term yields and a whole host of other problems. Now, of course, we're a long way from that as things currently stand. The first thing that needs to happen is that the nominee has to go for a Senate confirmation hearing. So I'll be watching that very closely for clues from the nominee as to how they think about the policy path, how they think about the interaction between monetary and fiscal policy, and how they think about the independence of the Fed. And then once that nominee takes over, we expect interest rate cuts to start again after a pause following the Fed's cut in December. In our baseline, we're looking for two 25 basis point cuts in the second half of 2026. I think a little bit more easing than that could still be in the realm of credible and in fact could actually be quite supportive for the economy and the market. But if the new Fed Chair were to cut significantly more than that, then I think questions of independence, credibility, inflation will become much more pressing for 2026. 

Lizzy Galbraith

I'm Lizzy Galbraith, political economist in the Global Macro team, and the thing I'm going to be watching most in 2026 is how upcoming elections affect the fiscal, and indeed, the broader political and policy outlook for some of the major economies. So starting in the US where we have the upcoming mid-term elections in October 2026, one of the themes here is that mid-term elections, generally speaking, are not positive elections for the incumbent president's party. They tend to lose seats, particularly in the House. Now in this particular election cycle, the House is going to be very closely contested. Republicans hold the House, but only by around three seats. So there's a very, very narrow margin and high potential that we see a swing away from the Republicans and towards the Democrats. Polling backs this up. Voters continue to be very concerned with cost-of-living issues, and they're becoming frustrated at the president's inability to bring down those prices. However, a curveball to watch when we're looking at the outlook here is going to be ongoing efforts on the part of both parties to re-district state level seats in favour of their incumbent parties. At the moment, this doesn't look like it's going to have a significant outcome on the overall election, in that both parties have roughly gained the same number of seats in their current redistricting efforts. But this is not something that we think is over, and it's going to be a key indicator to watch as we get closer to those elections. For now, we think that Democrats hold a slight advantage given polling, but re-districting could yet swing that in Republicans' favour. Over the Atlantic in the UK, local Scottish and Welsh elections are going to be a key test for the incumbent Labour government, and in particular, Prime Minister Keir Starmer. The Labour Party has been polling particularly poorly over 2025, and it appears to have lost around 50% of the voting coalition that brought it into power last year. If this polling holds and we see poor elections for Labour across those elections, which are due in May, then a leadership contest or a leadership challenge against Prime Minister Keir Starmer is a key risk. And following on from that, if we do see a change in leadership, then market concerns about fiscal policy under the next Labour prime minister could well become a key story in the second half of 2026.

Paul Diggle

Hi, it's Paul, Chief Economist at Aberdeen. My key question for the year ahead is, is there an AI bubble and will it burst? I think the short answer is no, at least not yet, but it's one of the downside risks for 2026 in among a baseline outlook which is in general upbeat. There are certainly bubble-like signs in AI-related equities. The S&P 500 and the ‘Magnificent Seven’ technology stocks specifically have had a very strong run. The former is up around 80% over the past three years, the latter by more still. And that's left certain valuation metrics looking extended. The Shiller cyclically-adjusted price-to- earnings ratio is around 40 times - close to dot-com era excesses. Market concentration is high and there is a worry that the AI-related capital expenditure boom, which has supported US real economy GDP growth, could be one large capital misallocation. However, I don't think that should be the baseline expectation for 2026. And I'm actually optimistic about continued support for US GDP growth from capex and a positive stock market wealth effect. And that's because US technology companies' rapid share price appreciation has been justified by robust forward earnings growth such that price-to-forward earnings valuation ratios in the mid-20s do not look excessive. Now that could just mean that the bubble is in earnings expectations rather than valuations, but the current environment is characterised by high hardware utilisation rates, broadening real-world use cases for AI and therefore strong fundamental demand. Nevertheless, the risk scenario of a possible AI bubble bursting is a realistic enough prospect that investors must be thinking about building in protection against this outcome. Should any AI bubble burst, it would likely send the US economy into a recession, albeit more like the early 2000s mild recession after the bursting of the dotcom, than the 2008 Great Recession after the housing crash. So our investment process here at Aberdeen includes multiple scenario stress tests involving a rapid sell-off in AI stocks, a liquidity crunch triggered by this rapid selling that spills into other asset classes and a recession in the real economy. We are looking to build portfolios that offer diversification from this and other risks while still offering upside exposure to positive risk sentiment. 

Bob Gilhooly

My name is Bob Gilhooly, I'm the senior emerging markets economist. And my key question for 2026 is: will China's anti-involution campaign banish China's low inflation? In plain English, involution is a self-defeating competition and lingering excess capacity, which effectively cannibalises company profits and embeds disinflationary pressure. Indeed, while the rest of the world has been struggling to shake off the inflationary shock from the pandemic, 2025 marks the third year of near-zero CPI inflation and a record-breaking ten quarters of the GDP deflator being in negative territory. I guess acknowledging you have a problem is of course a positive step and the authorities are likely, I think, to have some success in reducing excess capacity in a few sectors, specifically batteries, solar manufacturing and autos, which have all been flagged as focal points for policy. And there's, I guess, a little bit of evidence that authorities have persuaded car manufacturers to step back from their price war. We have seen car prices firm over the past six months, for example. But I'm pretty sceptical that this campaign is actually going to succeed. First of all, you know, just telling firms to raise prices doesn't really deal with the underlying excess capacity problem and there's always going to be an incentive to try and steal market share and put your competitors out of business when you're running a fraction of your potential. Second, you know, this is definitely not a free lunch. Local governments might not have the stomach to put lots of firms out of business to deal with excess capacity. And while you do this, it can also be somewhat disinflationary in the short term via second round effects from employment and just as the scaling back ripples through the supply chain and broader firm ecosystem. Third, tolerating such a prolonged period of tepid inflation might have actually already reset inflation expectations lower, making low inflation stickier and also blunting some of the recent policy-driven loosening of financial conditions. Fourth, and arguably maybe most importantly, geopolitical tensions continue to motivate strong investment in strategic manufacturing sectors, which is likely to keep the supply-side bias of policy firmly in place. Indeed, there isn't much sign of a change in direction coming out of the 15th Five Year Plan. All of which suggests that even if policymakers can keep real GDP growth going at a decent clip, for example by leaning into the green power rollout, tepid inflation in China is likely to be here to stay. And while that's going to make, I guess, debt dynamics a little bit tougher in China, we'd also expect China's excess capacity to be filled globally via lower goods prices and tougher competition for manufacturers outside of China, none of which, of course, is going to reduce geopolitical tensions.

Tetty Addy

Hi, I'm Tettey Addy, emerging markets analyst. The main question for me next year is: what will be in store for Latin America's US ties and electoral cycle? So starting with Mexico, it was one of the first markets in Trump's crosshairs for tariffs at the start of this year, but Mexican exports to the US have continued to grow modestly, being supported by broad tariff exemptions under the USMCA and Mexico's deep integration in US supply chains. Mexico's main concern next year will be the trilateral review of the USMCA due to start in July. We still have the core view that the North American trade deal will stay intact, with Mexico and Canada keeping preferential access to the US market. President Claudia Sheinbaum has so far done a good job of appeasing Trump on trade and border issues after all, so Mexico should remain well-placed to benefit from US nearshoring. But right now, it looks like serial annual reviews for the USMCA are more likely than a more secure extension, with Trump wanting to retain optionality for tariffs and other means of getting concessions from the US's neighbours. Now, as for elections next year, the biggest in Latam will be Brazil's in October. Right now, it's looking like President Lula will be facing Flávio Bolsonaro, the son of the former president, as his main contender. But the candidates will be finalised around mid-year. Now, Lula's currently enjoying a rebound of support after his tough stance against Trump's tariffs paid off with relief for key sectors, but voters there are still concerned regarding the cost of living and security, which the opposition will look to tap into. Now, it's still too early to call, but the result will have major implications for market sentiment around Brazil's fragile fiscal outlook. Now, on top of Brazil, next year will also see elections in the likes of Peru and Colombia. These are all likely to get Washington's attention to varying extents. Trump has demonstrated this year a willingness to intervene vocally and economically to support perceived allies in the region. We saw this with his tariff hike for Brazil in the summer, in protest against Jair Bolsonaro's charges there, and Washington's support measures for President Javier Milei, ahead of Argentina's mid-terms. Now, this all forms part of the Trump administration's new version of the Monroe Doctrine, which sets out geopolitical dominance in the Western Hemisphere as a key priority. We've also seen this with the US naval buildup in the Caribbean and a pressure on Venezuela. So all of this together will be a key theme that we monitor for Latin America in the coming year.

Michael Langham

Hi, I'm Michael Langham, our Emerging Markets Economist based in Singapore. The question I'm asking ahead of 2026 is can growth in emerging markets excluding China, continue to surprise to the upside? Heading into 2025 that outlook seemed challenging. You had this narrative of US exceptionalism sucking in global capital flows and trade policy uncertainty weighing on investment. Yet the big surprise was how resilient EM growth proved. The dollar weakened, oil prices fell, and trade held up better than expected. Monetary easing also broadened out across EMs. So the question is, can this persist? On the positive side, the benefits of EM rate cuts should feed through next year. Where rates remain high, like Brazil, there's room for easing as well. Global fiscal policy will be more supportive, and EMs face a busy election calendar, so we may see some fiscal support come through via that. But challenges remain. Tariff uncertainty hasn't disappeared, and the political climate is heating up. Sitting here in Asia, it's hard to ignore protests in the Philippines, in Indonesia, and border clashes in Pakistan and India, Cambodia and Thailand. So expect 2026 to be a year where we see bigger divergences across EMs in terms of performances. The question will be if the good reform and fiscal stories of 2025, such as South Africa and Malaysia can continue that, and how much we see policy deteriorate in places like Hungary ahead of elections, or the pressure on central banks in places like Indonesia. Overall, I feel more positive on consensus on India. We've seen positive tax and labour reforms and trade negotiations are advancing and sentiment as well could turn sharply if US tariffs ease. In short, 2026 won't be without risk, but the upside surprises may not be over yet. 

Sree Kochugovindan

My name is Sree Kochugovindan and my key question for the year is: how has Japan's political landscape shifted this year under the leadership of the new prime minister, Sanae Takaichi? What are the implications for markets and the economy going forward? So just as a quick reminder, Sanae Takaichi won the ruling LDP party leadership contest. She went on to form a new coalition with the Japan Innovation Party before taking over as the first female prime minister of Japan. Now, this marks a fascinating new phase for Japan's political and economic outlook. The early market reaction signalled expectations for Abenomics 2.0. So what does that mean? That implies aggressive monetary easing and fiscal expansion. But the ruling coalition faces constraints of being a minority in both houses. Plus, there's a problem of a highly sensitive Japanese bond market, which will make excessive fiscal expansion very difficult. So starting with monetary policy, we expect the Bank of Japan to start the new year with policy rates at 0.75 percent. Now, this will mark a fresh 30-year high, breaking through that 50-basis point threshold. Further hikes, though, will become more challenging. So we do expect a very slow pace of hikes from hereon. Headline inflation remains elevated, but food inflation has driven the bulk of that rise. Now, this will continue to decelerate from the record highs that we saw last year and pull headline inflation lower over the course of 2026. The Bank of Japan will be watching core services inflation very closely because they want to see signs of sustained domestically generated inflation. Meanwhile, wage growth is slowly improving over the past two years. But core base pay remains just shy of the 2 percent annual growth rate that they are looking for. Japanese corporates that are most affected by tariffs may find it hard to raise wages next year and raise bonuses. And it's widely expected that next spring’s wage negotiations will be weaker than what we saw last year. Now, turning to fiscal policy, the cabinet approved a supplementary budget at the beginning of December – 21 trillion yen stimulus package. And this is up from 13.9 trillion last year. But the bulk of this, almost 12 trillion, went to targeted price relief measures and support for households. So the multipliers for growth are not particularly high. But next on the agenda will be the fiscal year 2026 budget plan. Details of this will emerge late December, further details in January and final approval by March. And this is expected to focus on investment incentives for businesses, strategic industries such as tech, AI, semiconductors, quantum computing, but also increased defence spending. And on that note, another theme to watch for Japan next year will be the geopolitics. While tariffs and US trade was the main focus of 2025, next year, trade with China, given the recent tensions, will be very closely watched.

Felix Feather

Hi, I'm Felix Feather, European economist at Aberdeen and the key question I have for 2026 is: will fiscal easing begin to bite next year? I think the context is important here – it's the reason I want to ask this question because we had three big, big changes to the European fiscal landscape last year. So one, we had changes to NATO commitments. They've gone up and NATO are now expecting higher defence spending from all member states, a lot of whom are European. There were also changes to EU fiscal rules, the introduction of an escape clause, which should allow countries that want to take it up to indulge in greater deficit spending. And also big changes to the German fiscal landscape. So the debt brake still is there, but it's been reformed so strongly that it's a lot less restrictive. There's also a very large German infrastructure package, which is beginning next year. And it will indeed be Germany that's the engine of fiscal easing next year. According to the draft budget, we could expect a fiscal impulse. So the boost to GDP after cyclical factors and interest payments are accounted for could be around 1.5% of GDP. That's a really big number, but I'm sceptical that the actual boost to GDP will be that large. That's because procurement bottlenecks, project readiness, could hold up the implementation of funds for infrastructure spending. And it's a similar story in the defence space as well. A lot of spending could go towards topping up existing contracts rather than actual new production of defence materials. There's also the complication of what's happening in France and some other fiscally constrained countries within the Eurozone. So of course, France needing to reduce its deficit, it currently has the largest of the major European economies. Budget negotiations are still ongoing. We're recording on the 11th, and it could be that the political situation has changed again by the time this goes out. But the bottom line is that France will not be indulging in any fiscal easing anytime soon. It will be doing the opposite. And the fiscal impulse to the economy [will] actually be negative in 2026, and probably beyond as well. So what this means overall is that we see Euro area fiscal policy changes as a net positive, but concentrated in a few key economies, notably Germany. And crucially, we see the benefits of this fiscal easing coming more in 2027, 2028 and beyond, rather than next year.

Paul Diggle

Hi, it's Paul again. That is about all we have time for this week and indeed this year. Thank you for tuning into Macro Bytes during 2025. We've really enjoyed speaking to our guests – and to you – during what has been a massive year in global macro, politics and geopolitics. And as you've heard from the economics team here at Aberdeen Investments there is going to be no let-up in 2026. We will be here analysing macro and markets through all that. But until then, goodbye and good luck out there. 

 

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