Deep Tensions Masked by Stable Cyclical Conditions
Financial markets are entering 2026 with a level of calm that belies the scale of structural shifts underway in the global economy. Market-based volatility remains compressed across asset classes despite the high degree of uncertainty stemming from two major paradigm shifts, namely the global resurgence of trade protectionism (a shift toward mercantilist policies globally) and the rapid acceleration of AI technologies.
While these forces have the potential to reshape supply chains, alter geopolitical relations, and impact productivity, investors have thus far treated them as long-term factors and have taken a relatively sanguine view about short-term effects. In part, this stability is consistent with relatively benign cyclical economic conditions (ongoing modest economic expansions, soft but resilient labor markets, and inflation hovering around or just above central bank targets) across most of the world.
The disconnect between unfolding structural change and continued market stability will be a key dynamic to monitor as 2026 progresses.
Duration is Under Pressure
Over much of the decade prior to the pandemic, long-term rates remained very low, thanks to fiscal restraint across much of the world, muted demand for borrowing from the private sector, and large-scale asset purchases by central banks. Now, this dynamic is changing. Fiscal deficits are high and potentially set to rise in a number of countries, resulting in increased government bond issuance. Meanwhile, monetary authorities have tightened policy to bring inflation back to target and begun to shrink their balance sheets. This means that central banks are stepping back as the marginal buyers of government securities.
In the US, it is worth noting that the budget deficit would be even larger absent the nearly $200bln in customs duties collected in fiscal year 2025. With the US Supreme Court potentially set to strike down some or all of the IEEPA tariffs, the US would see additional long-term increases to the deficit in the absence of other sources of tariffs revenues.
We have already seen these pressures resulting in steeper yield curves across the developed world over the last two years, but curves may have plenty of room to steepen further given the supply of long-term government debt set to come down the pipe globally next year.
An Inflection Point for Short-Term Rates?
Over the last few years, investors globally have discounted a steady decline in short-term interest rates and central banks have delivered largely as expected (with the only question being how much and how fast).
Looking to next year, several central banks are set to ease further and there is very little meaningful tightening discounted across the developed world (Japan is an exception, having recently raised rates to 0.75%, the highest level in the last 30 years). This benign interest rate pricing is consistent with a benign inflation outlook.
Given certain ongoing shifts in market structure stemming from changes in trade, immigration, and fiscal policies, there is a risk of inflation running hotter over the medium term compared to the pre-pandemic period (though potential productivity gains from AI makes an assessment of the inflation outlook challenging).
In the US, there are factors like the fiscal support from “One, Big Beautiful Bill” and strong AI capex investments in 2026 that will likely boost the economy and put upward pressure on inflation. Easy financial conditions will also be supportive to growth. Finally, some analysts have noted that the 2026 November midterm elections may incentivize Republican lawmakers to deliver additional policies designed to stimulate demand.
A reacceleration of inflation and an accompanying return to monetary policy tightening would present a material shock to the financial system given that current valuations of risk assets appear to be predicated on continued easy in coming years.
Monitoring Storeholds of Value
This past year, a combination of factors (including concerns about central bank independence, political uncertainty in France and Japan, the US government shutdown) stoked fears regarding fiscal sustainability, inflation, and the value of fiat currency.
As a result, gold saw a historic rally versus all fiat currencies, reflecting a shift of private savings into an asset not connected to the Western financial system, which is safe in the event of a conflict, and which can be reliably counted on as a storehold of value. Notably, we did not see the same market action in Bitcoin, with the “counter-currency” not behaving at all similarly to gold as a hedge against debasement (instead trading more in line with other risky assets, such as high beta equities).
The key question for private investors is whether the price of gold has peaked or whether the factors that have contributed to its rise will continue to support demand. At prices north of $4000 / troy oz, demand may soften as investors turn to relatively cheaper alternatives as store of value. That said, we may also be in the early innings of a shift where gold assumes a more important storehold of value in investor portfolios. Given gold constrained supply and the fact that much of the world supply is locked up in illiquid holdings, even a modest shift in global savings into gold could support a significant rally.
While the dollar is ending the year down close to 6 percent on a trade-weighted basis, this of course, does not necessarily mean the dollar’s status as the preeminent global reserve currency is under threat, at least in the short term. In fact, even as the dollar stabilized versus other fiat currencies, as shown below, strong demand for gold persisted in the second half of the year.
Watching the US Premium and the AI Race
A final dynamic to watch closely in 2026 is the AI race and the AI capex buildout. Investors continue to be sanguine about prospects for US companies in the AI ecosystem, both in absolute terms and relative to international peers. As shown below, the price to 12 months forward earnings ratios for the S&P 500 continue to trade at a notable premium to major international indices—even after stripping out the Magnificent 7 and even relative to the premium we saw US equities command throughout the 2010s.
This valuation gap likely reflects a combination of compressed US equity risk premium and expectations for outsized earnings growth from US companies. This assessment extends beyond a handful of mega cap stocks, presumably a reflection of expectations that AI will deliver broad, sustained earnings growth across the U.S. corporate landscape.
This makes the second chart particularly important. Oracle’s, Alphabet’s, and Nvidia’s stocks all saw meaningful stock swings this year, underscoring that it is far from clear which business model will win the AI race in the end. The competitive dynamics among infrastructure providers, chipmakers, and platform companies remain fluid, and the distribution of future AI profits is still highly uncertain. For investors, understanding which firms will capture AI value is central to assessing whether asset valuations are justified—or vulnerable—in 2026. This makes the path of AI competition one of the most important market drivers to monitor in the year ahead.
Elevated valuations do not necessarily imply poor outright or relative returns in the future, but they do raise the bar for what it will take to surprise market participants to the upside. This increases US equities exposure to any disappointment in earnings, policy, or AI adoption timelines.
