Q1 2026 Market & Economic Outlook

 

Current Economic Views

Despite some challenges in 2025, the U.S. economy remained resilient and grew at a rate of approximately 2.3%. Businesses and consumers navigated through layers of uncertainty, including tax policy (the One Big Beautiful Bill Act), trade tensions (tariffs), spending policy (government shutdown), and interest rates (Federal Reserve).

 

The Fed acknowledged the ongoing uncertainty in the economy and lowered interest rates three times to support economic growth. While inflation remains above the Fed’s target of 2%, various measures are currently around 3%. At the December meeting, the Fed increased its 2026 GDP projection to 2.3% from 1.8% and trimmed its inflation forecast to 2.4% from 2.6%.

 

Last year, job growth slowed, although the unemployment rate remains at a low overall level of 4.4%. Job growth averaged about 50,000 per month. The fourth quarter was weaker, due to government job cuts and buyouts. The job market remains roughly balanced, with the total number of job openings nearly equal to the total number of job seekers. Wage growth has slowed to 3.8% year over year, approaching the level historically consistent with inflation near the Fed’s 2% target. Consumer spending has been boosted by wealthy households, which have benefitted from rising equity and real estate prices.

 

The housing industry remained sluggish. While the Fed has cut its benchmark rate, the central bank does not directly control mortgage rates. The 30-year fixed mortgage rate has remained above 6%. For context, over 50% of outstanding mortgages have a rate of 4% or less.

 

Tariffs increased last year, but the economy remained resilient overall. While trade deals were negotiated with multiple countries, some tariff-sensitive industries continue to show higher inflation levels as some costs are passed along to the final consumer.

Looking ahead

The U.S. economy enters 2026 with some momentum. The delayed impact from previous Fed rate cuts should lower the interest burden. The first few months of the year should see a boost in tax refunds from the OBBBA. Additionally, the bill includes incentives for business expenditures. Taken together, these factors suggest that business spending may expand this year.

 

Job growth may continue at a slow pace. The labor market faces some near-term supply headwinds as Baby Boomers retire and immigration policy is restrictive.

 

With many of the tariffs impacting prices in the second quarter of last year, this year’s first quarter could face higher year-over-year comparisons, especially if more tariff costs are passed along to consumers. An unexpected shift towards 3.5-4% would be a challenge for the Fed and push out any additional rate cuts.

 

Government debt levels remain a concern. The U.S. deficit-to-GDP ratio is near 6% — a level that is consistent with a recession; however, this is inconsistent with an unemployment rate of 4.6%.

 

Trade and geopolitical issues (Venezuela, for example) are unknowns. Lastly, trade conflicts remain an issue heading into the year, although some of this has been resolved.

Current Investment Views: Equities

The S&P 500 rose more than 2% in the fourth quarter and approximately 18% for the full year. These gains led the index to all-time highs, reflecting strong investor enthusiasm. Last year was the third straight year of positive gains. The index increased by about 26% in 2023 and 25% in 2024. It is up roughly 80% over the last three years. Equity markets have been on a hot streak. Also, there is optimism for this year.

 

However, last year was still very concentrated. About 10 companies drove half of the S&P 500’s overall increase. The Magnificent 7 remained prominent as tech continued to play an outsized role in equity market gains. The industry’s valuations are largely stretched in some cases, and there has been significant volatility, partially due to uncertainty surrounding Generative AI.

 

The takeaway: Tech can deliver big gains but also steep losses. The range of possible outcomes regarding AI’s future is vast.

 

Investor concerns over AI and data center infrastructure spending increased during the quarter. Many question if high spending will bring matching returns and when those returns will arrive. For now, the hyperscalers (the mega-tech companies collectively spending hundreds of billions of dollars on AI-related ventures) say they cannot meet demand, signaling more data center construction.

 

Momentum stocks (those with strong and sustained upward price movement) continued to be the primary driver of overall performance. However, there were signs of a potential shift towards more value (cheaper stocks), as the area has been relatively inexpensive. Solid returns on value stocks would be a welcome development for investors who continue to hold diversified portfolios.

 

The broadening out at the end of last year also leads to hopefulness for this year.

Looking ahead

Domestic equities started 2026 with positive sentiment and many bullish forecasts. However, there are several potential issues.

 

Many U.S. equities are priced for perfection, with the S&P 500 well above long-term valuation averages. This can boost returns but raises downside risk. If 2026 profits slow or margins fall, earnings multiples could contract swiftly.

 

The AI revolution will likely remain central this year. The main risks are timing and returns. If AI adoption is slower than expected or pricing power weakens as competition intensifies, earnings forecasts could take a hit.

 

Investors expect cooling inflation and lower rates, but inflation may stay sticky due to AI spending or tariffs. If the central bank keeps rates higher or tightens conditions, bond yields would rise, which would in turn raise equity discount rates and challenge high valuations.

 

Geopolitical risks still remain in the backdrop. Conflicts that rattle the energy markets or disruptions to critical supply chains could prompt investors to shift away from riskier investments.

 

Lastly, U.S. consumers will play a key role (as always). Wealthier households continue to spend, but less wealthy ones are stretched. How quickly and widely the One Big Beautiful Bill Act impacts consumers will be worth watching.

Current Investment Views: Fixed Income

The Federal Reserve cut the benchmark fed-funds rate three consecutive times around the end of last year and it now sits at 3.50-3.75%. Last year, the 10-Year U.S. Treasury Yield fell 40 basis points to 4.17%, and the 2-Year U.S. Treasury Yield fell 77 basis points to 3.47%. Reasons for the decline in yields across most of the curve include:

 

• The labor market showed clear signs of weakening. Job growth slowed to the slowest pace since the pandemic, and the unemployment rate (while historically low) reached its highest level in several years.
• Despite concerns about price increases related to tariffs, inflation continued to trend downward, closer to the Fed’s 2% target, reaching its lowest level since early 2021. Longer-term inflation expectations also remain well-anchored.
• Investors gained some clarity on federal policies, particularly related to trade. Tariff revenue, certain spending cuts, and calculated issuance by the Treasury Department helped keep longer-term rates from moving meaningfully higher.

 

Credit spreads (the excess yield investors demand for holding a corporate bond instead of a similar U.S. Treasury) remained near their lowest levels of the century. This suggests that the bond market currently sees little reason to worry about the near-term economic outlook.

 

The fed-funds futures (market-based data points used to project monetary policy changes) expect an additional 59 basis points of cuts to the fed-funds rate in 2026.

 

The market believes the Fed can largely get the fed-funds rate back to neutral (estimated to be around 3.00-3.25%) within the next 12 months.

Looking ahead

In the Fed’s latest economic projections, the median real GDP growth for 2026 increased to 2.3%, well above the Fed’s previous estimate of 1.8%.

 

Core PCE (the Fed’s preferred inflation metric) was revised down to 2.5% in 2026 from 2.6% earlier. Policymakers seem to be more encouraged that tariffs will not create lasting price pressures.

 

The median unemployment rate projection for the end of 2026 remained at 4.4%, suggesting a largely stable, if not improving, labor market.

 

The median projection calls for only one quarter-point cut to the fed-funds rate, although the dispersion of projections is incredibly wide.

 

The diverging views at the Fed are healthy and expected. Inflation remains above target, the labor market is weakening, while political uncertainty continues to muddle the outlook. The new Fed chair, whose term will begin in May, will likely be unable to build overwhelming consensus for lower rates unless the economy weakens significantly.

 

Credit spreads remain near their historical lows, suggesting limited room for further tightening. Economic and political uncertainty are plaguing both the market and the Fed, making it difficult to forecast where yields across the curve are headed over the near term.

Asset Spotlight: Rare Earth Elements

Rare earth elements surged in price last year amid the ongoing trade war with China. These elements are often the backbone of modern equipment — including smartphones, electric vehicles, wind turbines, and, perhaps most importantly, defense technology. They can be used to manufacture heavy magnets, which are essential for applications such as hard drives, motors, and generators. Global demand is unlikely to slow, especially since parts of Europe are increasing defense spending.

 

Almost all of the 17 rare earth elements today are processed in China. Recently, the U.S. and others have been scrambling to catch up and gain some independence. This could take years, as mining, production, and refining require a significant amount of infrastructure. Regardless, forecasts expect the U.S. and other nations will still have some dependence on China for the foreseeable future.

 

Despite the name, rare earth elements are not as rare as their name suggests and are actually more abundant than gold and silver. The U.S. Geological Survey estimates China holds 49% of the known rare earth element reserves, while Brazil (24%), India (8%), and Australia (6%) also have reserves. However, China extracts 59% of global rare earth elements, refines 91% of them, and manufactures 94% of the elements needed to make magnets for modern equipment.¹

 

China’s dominance in this area comes from its production capability. Processing these elements is a complex, energy-intensive, and environmentally risky process.

 

In the 1970s and 1980s, the global economy was more industrial-based, and oil was a crucial input to production. As the global economy continues to rely on technology, rare earth elements will likely remain important not just to the tech sector but to multiple industries as they adopt future technologies.

Looking ahead

Global demand for rare earth elements could triple over the next decade.²

 

Defense spending across numerous countries is likely to rise, which is partially why demand should continue to surge. U.S. officials know that dependence on China is an issue (especially during a trade war) and have started efforts to become more self-reliant. An issue is that it will take years to develop the infrastructure, and even then, China will play a large role.

 

Barclays estimates that China’s share of rare earth element production will drop to only 75% by 2035, down from over 90% today.

 

The U.S. has a two-pronged approach to this problem: increasing domestic capabilities and exploring deals with foreign nations.

 

Recycling rare earth elements is also gaining some traction. However, less than 1% of rare earth elements are currently recycled. Analysts expect it will take decades to build out the infrastructure to handle this on a large scale.

 

The U.S. is often the world’s innovation leader. If the nation wants to continue leading the world in defense applications, alternative energy endeavors, and technology components, then it must stay focused on creating independence in the rare earth element sector.

 

¹ Barclays Special Report (Nov. 20, 2025 edition) via International Energy Agency.

² McKinsey & Co.: https://www.mckinsey.com/industries/metals-and-mining/our-insights/powering-the-energy-transitions-motor-circular-rare-earth-elements#/