As we move into 2026, global markets appear superficially calm. Inflation has moderated, stock markets have bounced back and continue higher, and growth - while uneven - has avoided outright recession in most developed economies. 

On the horizon, fiscal sustainability, policy divergence and technological disruption are all becoming more prominent drivers of markets. In many cases, these risks are interconnected, reinforcing each other rather than acting in isolation. The complexity is further accentuated by the shifting state of geopolitics, where the post WWII rules-based order is being replaced by the “might is right” approach of the current US Administration.

Three key themes to watch as we move into 2026:

• Developed economies need to choose between indulging the electorate or pacifying bond markets; political inflexibility in the UK provides a cautionary case study.
• Interest rate divergence is once again becoming a meaningful FX driver.
• Artificial intelligence has evolved from a thematic equity story into a genuine macro variable.

Fiscal Reality Bites

The UK is increasingly a bellwether for other advanced economies grappling with high debt burdens and constrained policy options.

The core issue is fiscal arithmetic. Growing debt levels are not unique to the UK; they are a defining feature of most developed economies. Crudely speaking, governments have two levers available: cut spending or raise taxes. In 2025, the Labour government decisively chose the latter.

Earlier attempts to reduce spending - most notably winter fuel cuts and proposed welfare changes - were met with strong political resistance. Backbench pressure effectively removed meaningful spending cuts as a viable option for the government, leaving tax increases as the primary tool for fiscal consolidation.

The most recent budget was widely viewed as a non-event in market terms, but that in itself is telling. Rather than providing a growth impulse, the measures are expected to weigh on economic activity, reinforcing an already fragile economic outlook.

Early warning signs are now emerging. Consumer spending remains muted, growth data has consistently disappointed, and unemployment has risen to post-Covid highs at 5.1% - just 0.2% below peak pandemic levels. Inflation - while falling - remains sticky and elevated, with CPI at 3.2%, well above the Bank of England’s 2% target. Simultaneously, the UK is experiencing an accelerating brain drain among young professionals, further undermining its long-term growth potential.

The government’s current policy mix risks exacerbating these issues rather than resolving them. Higher taxes in a low-growth environment threaten to entrench stagnation, while political constraints limit flexibility. The UK may ultimately serve as a cautionary case study for other left-leaning governments facing similar trade-offs between fiscal responsibility and economic dynamism.

From a market perspective, the UK’s current state illuminates a clear risk for any developed economy that pursues fiscal consolidation primarily through higher taxation in a low-growth environment. As investment falls and confidence weakens, currencies tend to bear the brunt first, with capital flowing away from economies perceived to be structurally stagnating. At the same time, growing debt burdens and deteriorating growth prospects increase the risk of higher yields at the long end of the curve, as investors demand greater compensation for holding sovereign debt. The combination of a weaker pound and steeper long-end yields is particularly destabilising, and the UK may provide an early illustration of how quickly confidence in developed-market debt can erode when fiscal credibility comes into question.

Rates Diverge, FX Reacts

One of the defining macro themes heading into 2026 is the re-emergence of meaningful divergence in interest rate expectations. At the time of writing, markets are pricing approximately 60 basis points of cuts from the Federal Reserve, around 40 basis points from the Bank of England, and little to no easing - if not outright hikes - from the European Central Bank. This represents a clear break from the largely synchronised global tightening and easing cycles of recent years.

This divergence is already visible in yield curves. For the first time in many years, the US curve is meaningfully downward sloping, while the European curve is upward sloping. That contrast reflects differing growth dynamics, inflation pressures and fiscal backdrops across regions.

An additional risk for US rates is institutional rather than purely economic. 2026 brings the possibility of a change in Federal Reserve leadership, and under the current US administration, there is a non-trivial risk that a new Fed Chair is appointed who is far more politically aligned with the White House than markets are accustomed to. A Fed Chair perceived as an Administration sycophant would materially alter expectations around Fed independence.

Such an appointment would likely come with an explicit or implicit mandate to pursue meaningfully lower rates, particularly if equity markets wobble or growth softens. Even the anticipation of a less independent Fed could push markets to price a lower terminal rate and faster easing cycle, amplifying existing divergence between the US and other developed economies.

There are also clear FX implications. The first half of 2025 saw EUR/USD climb approximately 15% before consolidating in the second half of the year. If rate divergence widens further in 2026 - driven not only by economic fundamentals but by political pressure on US monetary policy - it could provide the catalyst for another leg higher.

For the US dollar, the balance of risks appears asymmetric. Rate expectations, rather than growth differentials alone, are likely to become the dominant driver, and those expectations increasingly skew toward lower US rates. For risk managers hedging back to USD, the pick-up we have become increasingly used to may continue to erode, leading some to look for more complex solutions to capture pick up. Conversely, EUR funds will see a reduction in cost which may entice some managers to investigate hedging for assets or gains which are currently unhedged.

AI Becomes a Macro Variable

Artificial intelligence moved decisively from hype to macro relevance in 2025.

The scale of expectations was most visible in equity markets. Nvidia and Alphabet alone accounted for roughly 34% of the S&P 500’s gains in 2025, while Palantir rose 142% over the same period. Corporate investment told a similar story, with Meta and Microsoft each spending tens of billions of dollars on AI infrastructure.

Such has been the magnitude of this growth that AI has become a genuine economic driver - and risk - for the US economy and, by extension, US monetary policy.

In 2026, there is a wide range of potential outcomes:

• AI changes little: Productivity gains remain elusive, adoption disappoints, and the much anticipated AI revolution continues to be “just around the corner.” The economy bumbles along broadly as it is today with limited macro impact. This increasingly looks like the least likely scenario.
• AI delivers significant productivity gains: This outcome is arguably already priced into markets, limiting further upside for equities. However, the second-order effects could be substantial - labour displacement, downward pressure on prices and rising social and political tension. In this scenario, the Federal Reserve would likely be freed up to cut rates more aggressively. Even before the full effects materialise (which could take years), the Fed would need to acknowledge and communicate a response to the structural deflationary risks posed by AI.
• AI fails to deliver and markets reprice: If earnings and project targets are missed and confidence collapses, we could see a sharp repricing in individual stocks - particularly market leaders like Nvidia, which alone represents 7–8% of the S&P 500. Given the concentration of gains, this could trigger a broader equity bear market. In that environment, the “Fed put” would quickly return to the conversation, with political pressure - potentially from the US administration - forcing the Fed’s hand toward rate cuts. 

Across the range of plausible AI outcomes, risks to US interest rates appear skewed to the downside. Whether through productivity-driven deflation, labour displacement, or a sharp equity market correction, each scenario increases the likelihood of a more accommodative Federal Reserve than is currently priced. The FX implications are less straightforward. Historically, falling equity markets have supported a stronger dollar, but that relationship has already shown signs of fragility. If Fed cuts are driven by a rapid rise in unemployment or social disruption linked to AI adoption, the negative rate differential effect on USD may eventually dominate. Timing will be critical, as will the extent to which other economies experience similar AI-driven shocks and how their central banks respond.

New World (Dis)order

Our analysis and outlook remain subject to tectonic geopolitical shifts. The US President’s second term is profoundly different in that he is asserting a new doctrine: “might is right”. Recent episodes in Venezuela, Nigeria, and the intended goals with regards to Greenland, are clear indications that the post-WWII rules-based order championed by the US and Pax Americana are under threat.

The rally in gold and precious metals, driven in great part by central bank purchases, may have some way further to go owing to this increased geopolitical risk.

More importantly as we enter a new world where the “main rule is that there is no rule”, investors be well advised to prepare for the following:

Periodic and cyclical bouts of volatility in various assets and geographies, as a result of geopolitical headlines.

The new game has no rules, and extraterritoriality is the new norm, some noteworthy risks are:

• capital flow restrictions
• sanctions on private corporations (vs. sovereigns)
• potential for seizure of foreign corporations and sovereigns, and their assets.

Bottom Line

Individually, each of these themes is manageable. Taken together, they point to a world in which policy flexibility is limited, market concentration is high, and downside risks - particularly to growth and interest rates - may be underappreciated. For investors and corporates alike, 2026 is shaping up to be a year where risk management matters as much as return generation.