A benign backdrop
Agreements that the US struck with key trading partners during the course of 2025 have reduced the uncertainty around trade that was sparked by US President Donald Trump’s package of tariffs announced on 2 April 2025, which he dubbed “LiberationDay.” We are beyond peak trade uncertainty now, with stable arrangements in place with key US trading partners.
In the US, we expect growth to accelerate early in the year thanks to a rebound from the government shutdown and fiscal stimulus ahead of the midterms. In Europe, a pick-up will be supportedby fiscal stimulus in Germany, with Japan taking steps too. In China, an acceleration can be expected later in the year, helped by reduced trade uncertainty and likely stimulus measures. We forecast inflation to edge up a shade in the US and Switzerland, and for prices to rise in China. In the euro area, the UK, and Japan, inflation should slow.
Monetary policy is also supportive. We expect the US Federal Reserve to cut interest rates further in 2026. This will help broaden the US recovery, even if there is a risk of upward pressure on prices. The market’s perception of the Fed’s independence and its ability to anchor inflation expectations will be important to watch. Under a new Chair, due to take over in May, we expect the Fed will lean towards supporting the economy rather than chasing the inflation target. We also expect monetary policy to be supportive in other leading economies.
US plans tariff “dividend”
Fiscal stimulus is broad-based and will broaden. In the US, the mid-term elections in November area “whatever it takes” moment for the Republicans. With the Democrats on track to regain the House of Representatives, President Trump needs to act. The midterms will come after the 2025 election victory in New York for Zohran Mamdani, a Democrat who once said: “Taxation isn’t theft. Capitalism is.” The abnormal is becoming more normal. President Trump’s response is a drive to “Make America Affordable Again”.
The Supreme Court is not ruling on whether Trump can levy trade tariffs but on how.
In the K-shaped economy, wealthy Americans have experienced significant wage growth, and their equity portfolios are thriving, especially those exposed to the so-called “Magnificent Seven” technology stocks. By contrast, Americans in the lowest income bracket face growing challenges. Wage growth for this group has been much smaller, tariffs are having an outsized impact and stimulus in the One Big Beautiful Bill Act (OBBBA) disproportionally favours the wealthy.
Fiscal measures to support lower-income consumers in the US can be expected ahead of the midterms. President Trump wants to pay out USD 2,000 cheques to most Americans – a so-called dividend funded by revenue from tariffs. This measure would disproportionately benefit lower-income groups. Questions remain about how it will be funded. A US Supreme Court ruling risks revoking the lion’s share of tariffs revenue, which could leave a big hole in revenues. However, the key message here is that the Supreme Court is not ruling on whether President Trump can levy trade tariffs but on how. Even if the Court ruling blurs the outlook, our conclusion is that tariffs are here to stay.
Europe is on the move
In Europe, a revival is underway. Germany, the region’s biggest economy, is leading the way – embracing fiscal expansion after years of budget restraint. This will more than offset consolidation in France, Italy, and Spain. A potential peace deal for Ukraine could also kick-start reconstruction, further boosting the European economy.
Space and defence technology are areas for growth in Europe. The German fiscal expansion is focused on infrastructure and defence spending, raising the prospect of innovation and spillover to the wider economy. Monetary policy is also supportive of a European revival.
European Union (EU) leaders want to integrate their economies further. The EU has set 2028 as a target date for completing the single market. This goal is supported by a Single Market Roadmap, which aims to remove persistent barriers in areas like energy, finance and telecommunications to increase competitiveness. The initiative also introduces a new “fifth freedom” for the movement of knowledge and innovation.
Japan embraces fiscal expansion
In Asia, Japan has stimulus plans of its own. Sanae Takaichi unexpectedly won election as leader of the ruling Liberal Democratic Party (LDP) in 2025, allowing her to become the country’s first female prime minister and heralding a new era of fiscal expansion. Japan's larger budget package, designed to boost growth, is slowing fiscal consolidation by prioritising economic stimulus over deficit reduction.
China looks beyond “involution”
In China, policymakers are trying to regain economic momentum after a real estate downturn and are investing in other sectors.
Chinese President Xi Jinping is focused on an anti-involution policy – essentially taking capacity out of the industrial sector. Under involution, Chinese companies engaged in a hypercompetitive grab for market share that often involved aggressive price cuts, spurring intense competition that regulators said damaged the economy.
The anti-involution policy marks a shift away from grabbing market share at all costs to prioritising margins. This will foster a culture of investment and allow companies to make profits, and it is one of the reasons we are positive on emerging markets. We expect the gap in corporate margins between the US and China to close.
Space and defence technology are areas for growth in Europe.
This benign global backdrop should support the world economy in 2026. We expect a closing of the gap in the K-shaped economy, from the bottom up.
1 — Consumer spending
US: consumer confidence by income bracket (Morning Consult)
2 — Capital expenditure
US private investment growth, with and without AI capex spending
3 — Mag 7 market return
S&P 500 index versus Magnificent 7 performance
