2026 will be a year of paradox

2025 will be remembered as a year when policy upheaval tested the resilience of the global economy in ways few anticipated. Trade tensions deepened, inflationary pressures lingered, and geopolitical fractures widened. Yet, against this backdrop of uncertainty, growth endured—powered by strong balance sheets, agile policy responses, and the accelerating march of artificial intelligence. These forces not only defined 2025, but they will also shape the contours of 2026. 

Growth endures despite global disruption

The United States sits at the epicenter of both global growth hopes and concerns. The recent government shutdown has clouded near-term visibility, but the economy’s underlying architecture remains intact. Corporate profit margins have held firm, enabling businesses to pivot through disruption, while household wealth gains have secured household balance sheets and sustained consumer spending. 

Beneath these familiar pillars lies a new engine: AI infrastructure investment. In the first half of 2025, AI-related capital expenditure accounted for nearly half of GDP growth—a staggering figure that underscores the scale of this structural shift. With technology firms showing no appetite to rein in spending, AI will remain a dominant force in the year ahead—although mounting concerns over a potential bubble may limit its ability to propel equity markets and household wealth. Fiscal policy will add a layer of complexity in 2026. 

The “One Big Beautiful Bill” promises a short-lived but potent stimulus: tax refunds for households and retroactive incentives for corporates that could temporarily lower effective tax rates and unlock free cash flow. While the direct impact may fade quickly, the investment impulse it triggers could reverberate well beyond the initial fiscal lift. This combination of fiscal support and structural investment creates a powerful backdrop for growth, even as cyclical uncertainties persist. 

Fault lines in a late-cycle economy

Yet, the U.S. economy is not without fault lines. Its K-shaped nature—where affluent households drive consumption while lower-income cohorts struggle—poses a structural challenge even if the aggregate impact remains muted. As the mid-term election year approaches, the Trump administration is paying closer attention to these lower-income segments, seeking to ease affordability pressures through potential cash transfers and more lenient tariff policies in select sectors. While fiscal constraints cast doubt on full implementation, the government’s attention to these strained pockets of the economy is likely to endure. 

Labour market dynamics will also warrant close attention: hiring has slowed, but layoffs remain contained, and unemployment is near historic lows. Labor demand is slowing, but shifting labor supply dynamics, such as tighter immigration policies, also appear to be in play. Put differently, reduced hiring signals a cooling economy, but not one on the brink of a labor market unravelling. AI adoption could also reshape employment over time, but in the near term, firms view it as a growth catalyst rather than a threat. The longer-term implications for labor displacement and wage dynamics, however, remain an open question.

For the Federal Reserve, the interplay of AI-driven investment, fiscal stimulus, and labor supply dynamics points to only a modest easing cycle. Furthermore, inflation remains above target, and the full impact of tariffs on price pressures is still unfolding – warranting a cautious approach. The Fed’s key challenge in 2026 will be to calibrate policy in an environment where structural forces, rather than cyclical ones, increasingly drive growth and inflation dynamics.

Nuanced, but stabilising global outlook

Globally, the picture is equally nuanced. Trade tensions will persist, shaping alliances and supply chains. China has defied fears of an export recession, with supply chains increasingly diversifying away from the U.S. and towards intra-Asian linkages. It has also stepped-up efforts to dominate the next wave of technological innovation, positioning the economy as a key beneficiary of the AI narrative. This willingness to lean even deeper into its external strengths and tech innovation will be important as domestic demand continues to falter amid measured policy stimulus attempts. 

China’s determination to preserve its current account surplus while reducing reliance on the U.S. poses a challenge for Europe. Heightened competition for export markets threatens Europe’s manufacturing sector and could introduce mild deflationary pressures. However, easing financial conditions and Germany’s long-awaited departure from fiscal austerity should support economic activity. Europe may not emerge as a standout performer in 2026, still, its solid macro backdrop and relatively low tech exposure—amid concerns of an AI-driven bubble— are likely to appeal to many investors.

In sum, the macro outlook is constructive, but latecycle dynamics are unmistakable. AI has been the dominant driver of recent market gains, yet questions around valuations, productivity payoffs, and energy constraints will fuel volatility. Rising debt-funded investment and increasingly circular deal-making add to the sense of fragility, even as innovation continues to inspire. The narrative of “AI as the productivity gamechanger” is compelling, but it is also vulnerable to shifts in sentiment, particularly as investors increasingly demand stronger returns on investment. 

2026 will be a year of paradox: lifted by innovation and macro resilience, markets may brim with optimism even as questions about the durability of tech-driven gains cast a subtle shadow. If macro foundations hold, markets can continue to climb the wall of worry. Yet in an otherwise benign global backdrop, technology—particularly AI—stands as both the greatest opportunity and the greatest source of uncertainty. Investors must stay positioned for transformative growth while mitigating concentration risks amid rising skepticism. The challenge will be to balance conviction with caution, embracing innovation without overlooking the late-cycle warning signals.

Principal Asset Management