Market Outlook 2026

Theme 1 – The Rate-Cut Narrative

The market is currently pricing in roughly three rate cuts, bringing the Fed Funds target range to 300–325 bps by December 2026. To some, this expectation appears overly optimistic, especially as AI-driven investment continues to keep U.S. inflation sticky. The debate centres on the Fed’s dual mandate: on one side, the argument that easing is justified to support a softening labour market; on the other, the view that persistently elevated inflation leaves little room for premature cuts.

The outlook for U.S. employment appears broadly stable. While the pace of job creation has slowed, the labour supply is also contracting. Recent shifts in immigration and work-visa policies have tightened the labour pool, and specialised shortages are emerging in sectors such as utilities and power infrastructure amid heavy AI-related capital expenditure. This offset between muted job growth and a shrinking labour force may keep overall employment conditions resilient.

Inflation, however, remains the more pressing concern. Tariff pass-through effects, continued fiscal looseness, and tightening labour supply all point toward persistently elevated price pressures. We expect U.S. inflation to remain above the Fed’s 2% target through 2026.

Taken together, the Fed faces a mixed but manageable employment picture and a clearly challenging inflation backdrop. Although labour demand is softening, this weakness is partially concealed by the declining labour supply. Rate cuts could be justified to address the slowdown in labour demand, but with headline employment still steady, the case does not outweigh the risks posed by sustained inflation. Considering the Fed’s dual mandate, we view the market’s expectation of a modest two to three rate cuts as broadly reasonable.

Theme 2 – Tariffs, Power, and Remaking of the Global Order

The investment landscape of 2026 remains fundamentally reshaped by the trade policies implemented by the US administration, particularly the aggressive tariff campaign launched in April 2025. This pushed the US effective tariff rate to its highest level since the 1910s.

Tariff escalation has hastened the shift toward a multipolar world, replacing globalisation with a regime centred on strategic autonomy. The US doubled down on fiscal expansion to support domestic growth and AI investment. Europe pivoted toward defence and infrastructure spending, with Germany reversing its austerity stance. Governments are also intervening directly in strategic supply chains that reflects reshoring, as trade volumes held up while supply chains were rerouted. For instance, despite a 17% decline in exports to the US through October 2025, China’s total goods exports grew 5.3% due to resilient non-US markets. [1]

The world’s engagement with Gold

After Western governments demonstrated their willingness to weaponise the financial system by freezing Russia’s foreign reserves in 2022, China has been ramping up its purchase of gold. As of July 2025, the PBoC (People’s Bank of China) held 2,300.4 tonnes of gold. This quantity represented approximately 8.6% of its total reserves. [2] The accumulation of gold by China is explicitly framed as a geopolitical move, to secure its financial assets against potential confiscation and debasement of fiat currencies.

Central Banks consistent and stable purchases of gold are seen as a key structural factor supporting gold prices. This ongoing strategic demand is expected to establish a price floor, keeping gold at elevated levels. The persistence of this structural demand is strong; for example, if the PBoC were to target the global average central bank allocation of 20% of reserves in gold, it would require an increase of over 3,000 tonnes, which implies that this structural demand is unlikely to vanish in the foreseeable future. [3]

Commodity markets

The commodity complex remains highly differentiated. Energy markets face persistent downside pressure, while industrial and precious metals offer clearer upside driven by structural and policy-driven demand. Agricultural commodities are expected to remain broadly range-bound, contributing limited directional momentum to the overall commodity landscape.

Oil and gas markets are entering 2026 with a widening supply-demand imbalance. Rising production from OPEC+ and non-OPEC producers, alongside accelerating inventory builds, points to continued pressure on crude prices. Natural gas faces a similar dynamic, as a large increase in uncontracted US supply is likely to weigh on spot pricing. In contrast, industrial metals benefit from strong secular demand linked to electrification and AI infrastructure. Copper is particularly constrained by limited mine supply growth and strained ex-US inventories, while aluminium serves as a key substitute metal, sharing similar demand drivers with a more elastic supply response.

Precious metals remain well supported both structurally and cyclically. Gold continues to attract sustained buying from non-Western central banks, reinforcing its role as a geopolitical hedge and anchoring a durable price floor. A US easing cycle in a non-recessionary environment should further support gold through lower real yields. Silver is expected to move in tandem with gold, with incremental support from rising industrial demand in electronics and photovoltaics.

Theme 3 – Key Industries for Hong Kong & China

We maintain a positive and overweight stance on China equities. This view is supported by favourable valuations relative to higher priced US Equities and China’s structural transition.

Technological Supremacy

China is accelerating its drive toward technological self-sufficiency and innovation, central to the upcoming 15th Five-Year Plan (FYP). UBS specifically notes China’s focus on algorithmic efficiency, self-sufficiency, and industrial applications. The AI boom is expected to be the main engine for earnings and profit growth, especially for technology sectors. China’s tech ecosystem is seen as increasingly resilient to US external shocks, supported by its dominance in strategic supply chains — China now accounts for about 70% of global solar module production [4], underscoring the depth of its strength.

Advanced Manufacturing and Self-Reliance

National policy emphasises moving up the value chain toward high-quality development, fostering growth in advanced manufacturing, robotics, EVs, and clean energy. China remains the world’s largest manufacturing base, accounting for over 30% of global manufacturing output, [5] giving it unmatched scale across key industrial supply chains. Automation is now deeply embedded in China’s production ecosystem, supported by its long-standing position as the world’s largest market for industrial robots.

Sectors and Opportunities

• Technology & Communications

Seen as the primary engine of earnings growth, including internet platforms, AI infrastructure, and cloud services. UBS specifically prefers advanced foundries, memory producers, AI server ODMs, and fabless chip designers. [6]

• Advanced Manufacturing / Industrials

A core beneficiary of self-sufficiency efforts and AI-supply-chain expansion, including robotics, automation systems, and industrial components.

Theme 4 – AI Beyond the Hype: Is the Growth Durable?

Building Risks

Despite its strong structural underpinnings, the AI ecosystem is exposed to several material risks that warrant close monitoring. A key challenge is the lag between capital investment and monetisation. While AI-related capex is expanding rapidly, revenue and profit contributions for many initiatives will take time to emerge, creating uncertainty around return on invested capital (ROIC). Elevated equity valuations further heighten the market’s sensitivity to any signs of slower adoption or weaker earnings delivery [7]. Another concern is the circularity of investment flows within the AI value chain. Large AI firms increasingly invest in, partner with, and procure from one another, creating interdependencies that could amplify vulnerability if capex growth moderates. [8] The growing scale of AI spending has also led to increased use of debt financing, introducing balance-sheet pressure and raising the importance of consistent cash-flow generation. Finally, the sector faces significant physical constraints, particularly in power availability and grid capacity. Data centre expansion is increasingly limited by regional energy bottlenecks, and the pace of AI infrastructure deployment will depend heavily on the ability to secure and scale power resources.

[9]

Structural, Long-Term

The AI trend is increasingly viewed as a structural, multi-year transformation that will shape global markets throughout the decade. While investor enthusiasm is elevated, the foundations of this cycle differ significantly from earlier speculative episodes such as the dot-com bubble. The companies driving today’s AI investment possess strong balance sheets, substantial free cash flow, and the capacity to self-fund large-scale capital expenditure. The global economy also remains in the early stages of AI adoption, with the most significant productivity benefits expected to materialise as enterprises across industries integrate AI to enhance efficiency, reduce costs, and expand capabilities. Taken together, the evidence suggests that the AI cycle is not a bubble at this stage, but rather a foundational technological shift with long-duration implications.

Implications

Given the durability of the trend and the evolving risk environment, the AI opportunity set is expected to broaden meaningfully over time. The next phase of the cycle is likely to extend leadership beyond early innovators toward enablers of AI infrastructure—such as industrials, utilities, semiconductor manufacturing, cooling and power-management solutions, and advanced networking providers. As AI integration deepens across industries, value creation is set to expand further toward adopters, including financial services, healthcare, and other sectors that deploy AI to enhance productivity and earnings growth. [10]

Theme 5 – Next Engines of Growth

Emerging Markets are poised for resilience and growth, driven by a combination of internal strength and external support. A primary cyclical driver is the expected softening of the US dollar and a continued Fed easing cycle. Lower US Treasury yields and a weaker dollar are historically supportive factors that improve financial conditions and attract capital flows.

Emerging-market credit ratings have remained notably stable, even as several developed economies have faced meaningful downgrades. Many EM economies display better fiscal health, with debt and inflation levels generally under control relative to historical standards. Against this backdrop, EM Local Currency (LCY) Government Bonds retains a favourable view, cantered on generating carry. With ~7-year duration and yields near 7%, they offer an attractive risk–return profile at a time when developed-market yields remain subdued.

The Banking and Financial sector enters 2026 from a position of stability, supported by solid fundamentals in both the United States and China. US banks remain well capitalised—with CET1 ratios around 12.8% for major institutions— and continue to deliver steady profitability, earning a 1.27% ROA and USD 79.3bn in Q3 2025, [11] signalling healthy balance sheets and manageable credit risk. Looking ahead, both markets stand to benefit from structural shifts that support higher fee income, including a pick-up in M&A, greater capital-markets activity, and steps toward regulatory simplification that reduce compliance burdens and encourage deal flow.

Theme 6 – The Cheap Yen may be nearing Its End

Japan’s outlook is constructive, anchored by a clear pivot toward fiscal expansion and improving domestic fundamentals. The incoming Takaichi administration is expected to pursue growth-supportive policies, with increased spending on infrastructure, defence, cost-of-living, and strategic growth industries. This fiscal impulse should underpin moderate but stable GDP growth, with 2026 forecasts clustered between 0.7% and 1.7%. On inflation, while headline CPI is expected to ease toward 1.6% to 2.0%, [12] upside risks remain due to labour shortages and wage pressures amplified by fiscal stimulus. In response, the Bank of Japan is expected to continue policy normalisation, with the overnight call rate projected to rise toward ~1.00% by end-2026. [13]

The Japanese yen is expected to appreciate against the US dollar as interest rate differentials narrow. This is driven by the BOJ’s gradual tightening cycle alongside prospective Federal Reserve easing. From a valuation perspective, the yen remains deeply undervalued on a real effective exchange rate basis relative to historical norms.

Reversal of the Yen Carry Trade

The yen carry trade is increasingly vulnerable to reversal as Japan pivots toward fiscal expansion and monetary normalisation [14]. The narrowing of interest rate differentials reduces the attractiveness of funding positions in yen, raising the risk of position unwinds. The implications point to a structurally higher risk of disorderly carry unwinds rather than a gradual adjustment. As yen volatility rises, leveraged short-JPY positions become increasingly unstable, amplifying sensitivity to global risk-off episodes. Even modest yen appreciation can trigger stop-outs. This shifts the yen from a low-cost funding currency toward a potential shock amplifier in global markets, with spillovers into EM FX, global equities, and rates via forced position reductions. 

Theme 7 – The Next Phase of Private Markets

Private Equity

Private equity exits are accelerating. After three slow years, exit values rebounded across all strategies in the first three quarters of 2025. The sharpest gains came from private placements (+77%) and IPOs (+38%), with secondary buyouts (+20%) and trade sales (+8%) also improving. [15]

The consensus view is that the private equity (PE) market is poised for revitalisation in 2026 following a period of suppressed dealmaking and liquidity constraints caused by high interest rates and volatility. Improving macroeconomic conditions, particularly stabilising interest rates and expected Fed easing, are expected to unfreeze the deal market. This outlook anticipates a rebound in both M&A activity and IPOs, serving as critical exit doors for PE firms to realise returns and increase distributions to limited partners (LPs). Increased M&A activity is expected, fuelled by lower financing costs and a more transaction-friendly regulatory environment, particularly in the US, as the Federal Trade Commission appears to be pivoting away from an intervention-first stance. [16]

Private Credit

The rising volume of M&A activity is expected to stimulate demand for Private Credit financing solutions. [17] As interest rates stabilise or fall, the debt servicing costs for floating-rate private loans should decrease, improving borrower liquidity and allaying some default risk concerns.

There is increasingly a critical need for selectivity and disciplined underwriting due to emerging signs of stress. Recent high-profile defaults, notably from the US auto sector (First Brands and Tricolor), have intensified scrutiny on this “shadow-banking system,” though these issues are generally seen as isolated and idiosyncratic, not systemic threats. However, 15% of borrowers can’t generate enough profit to cover their interest bills [18], and even a 1.25% rate cut would only lift many back to about 1.0× coverage, which offers very little breathing room18. Companies that missed early performance targets may be at higher risk of running into solvency issues. If borrowers with coverage below 1.0× start defaulting, lenders could see mid-single-digit losses, even though historical recovery rates sit around 65%18. Around 10% of loans include payment-in-kind (PIK) features18, which have delayed some defaults but don’t fix the underlying financial strain.

Source:

[1] Year Ahead 2026: Asia Pacific – UBS House View
[2] Outlook 2026 Global Asset Allocation | Societe Generale
[3] Outlook 2026 Global Asset Allocation | Societe Generale
[4] Solar PV Global Supply Chains | IEA
[5] World Bank Group Data
[6] Year Ahead 2026: Asia Pacific – UBS House View
[7] T.Rowe Price 2026 Outlook
[8] Outlook 2026 Global Asset Allocation | Societe Generale
[9] Is the Flurry of Circular AI Deals a Win-Win—or Sign of a Bubble? | Wall Street Journal
[10] HSBC Outlook, Think Future 2026
[11] Research Quarterly: US Banks – Financial & Regulatory Data | Securities Industry and Financial Markets Association
[12] HSBC Outlook, Think Future 2026
[13] Invesco Global Asset Allocation 2026 Outlook
[14] Yen carry trade in reverse: How Japan’s yield shift is shaping USD/JPY | Deriv
[15] Barclays Private Bank Outlook 2026, The Interpretation Game
[16] T.Rowe Price 2026 Outlook
[17] Goldman Sachs Asset Management’s Investment Outlook for 2026
[18] Goldman Sachs Asset Management’s Investment Outlook for 2026