2026 Market and Economic Outlook

As we bid farewell to a year that exhibited plenty of policy drama, we would love to say that 2026 is likely to be a return to calmer times. But while we may see some of the more impactful policy shifts of 2025 moderate and are highly unlikely to see anything close to Liberation Day, this year will have more than enough excitement of its own. Not only will we see the culmination of months of White House antagonism toward the Federal Reserve when President Trump gets to install a new Fed Chair, but 2026 also brings what is likely to be the most contentious mid-term election in quite a while. Add in the ever-growing question of just how durable the Artificial Intelligence (AI) trade is going to remain, and you have the makings of another memorable year.

It is against this backdrop, and with the full acknowledgement that shocks are as unforeseeable as markets are unpredictable, that we will attempt to offer insight into what 2026 may bring for the U.S. economy and markets.

But before we dive into the forecast, let us take a step back and assess the accuracy of our 2025 predictions.

Reviewing our 2025 Forecast

Despite the policy uncertainty we expected heading into 2025, we predicted that the U.S. economy would hold up quite well. Now, we obviously did not anticipate the scope and scale of the tariffs implemented on Liberation Day, but it is an interesting study in the resiliency of the U.S. economy that even with such a major shock, our rather optimistic forecasts were mostly on target.

Despite trade-related disruptions earlier in the year, the economy showed great resilience, finishing with above-trend real GDP growth. And in the face of severe supply-side labor disruptions from immigration reform, the labor market (measured by unemployment rate as opposed to job growth, as the latter is skewed heavily by these supply-side issues) only weakened slightly, finishing within our projected range. Inflation was perhaps our biggest miss, as goods prices were pushed higher due to tariffs, which overwhelmed our key presumed disinflationary driver (shelter). Even so, the Fed cut rates as expected, but the 10-year Treasury yield proved less stable, often dipping below 4% before finishing slightly outside our range due to stickier-than-expected inflation. Lastly, S&P 500 earnings growth came in at 11.9%, right at the top edge of our forecast - a very respectable showing given the headwinds that U.S. corporations faced throughout the year.

Overall, given what 2025 brought, including the restructuring of global trade and the longest government shutdown in history, we are pleased not only with the few narrow misses we had, but also with the market’s performance.

Looking Ahead: Our 2026 Economic Forecast

You may notice some similarities between our 2026 forecast and what we just reviewed for last year. Simply put, we expect the U.S. economy to continue its streak of resiliency, growing above trend for another year as policy uncertainty fades, fiscal support takes effect in the form of the One Big Beautiful Bill (OBBB), and monetary policy becomes more accommodative. Job growth may remain tempered by migration headwinds, but recovering labor demand should keep the unemployment rate stable. Inflation will move mostly sideways, as slowing shelter inflation is met with lingering tariff effects and ongoing pressure in core services. The Fed will cut, but we anticipate one fewer than the consensus simply due to this inflation pressure and, more importantly, the potential for a robust economy simply not warranting it. Similarly, the 10-year Treasury yield may come down slightly, but less than the Fed’s policy rate as inflation and fiscal concerns keep the former elevated. And finally, we anticipate strong earnings growth out of the S&P 500 due to the above-mentioned policy tailwinds, a broadening market, and strong ongoing AI investment.

2026 Forecast Backdrop

If 2025 flipped the script on geopolitical and economic norms, 2026 may be the year where we start to see what that truly means for the institutions and countries involved. And while the potential for shocks to the U.S. remains, especially surrounding Fed independence, fiscal spending, and AI, the true uncertainty may lie elsewhere.

U.S.-China relations appear to be perpetually on the cusp of deterioration, Russia and Ukraine are no closer to a resolution despite multiple rounds of talks, the EU is attempting to reshape NATO while enduring no shortage of political and fiscal woes, and Japan is facing its own currency and (potential) debt crisis. President Trump’s trade war, regardless of the Supreme Court decision, is still going to make waves, and on top of it all, Latin America is becoming a hotbed of polarization, as competing interests of the U.S. and China/Russia risk boiling over. The global landscape is fraught with risk, and there is a marked Tehran-Yalta-Potsdam feeling to the whole affair.ⁱ

2026 Economic Growth

As we survey the current state of the economy, we see the potential for steadier, more expansive growth in 2026. Last year, spending by higher-income households and exploding investment in AI helped the economy push through sizable headwinds including struggling lower-income consumers, contracting federal spending, and lackluster business investment outside of AI. With several catalysts emerging that could lift these weaker segments, growth in 2026 appears poised to broaden across the major parts of the economy.

Household Consumption

Household spending accounts for more than two-thirds of total economic activity, which means that the strength of the consumer is often the single most important driver of the U.S. economy. Fortunately, this segment proved remarkably resilient last year despite tariff concerns. However, beneath this headline growth, a worrying divergence emerged in spending patterns. 

While higher-income households benefited from faster wage growth and considerably greater exposure to rising financial markets, the other end of the income spectrum has been financially strained due to the larger relative impact of rising costs and high interest rates.

A second structural challenge to the consumer also emerged in the form of slower employment growth. Reduced immigration, deportations, and an aging population have limited the supply of workers, suggesting job creation will run slower than previous decades. And while this alone does not signal an approaching recession, it does limit how much employment growth can fuel future spending.

Despite these challenges, however, several drivers point to a solid year ahead for U.S. consumers:

• Tax cuts from the One Big Beautiful Bill Act (OBBBA) - Larger-than-usual tax refunds should give households a clear boost early in the year. Historically, middle- and lower-income families spend a significant share of refund dollars, making this an effective catalyst for consumption.
• Election-driven stimulus - Beyond the tax cuts and credits that have already been enacted, there is the potential for further action before the mid-term elections. President Trump has already floated the idea of using tariff collections to fund “dividend” checks for households, and with evidence building that the GOP congressional majorities are in jeopardy, it is increasingly likely that the administration will take additional steps to ensure a strong economy and tilt upcoming elections back in their favor.
• Lower interest rates - If policy rates continue to decline as expected, low and middle-income consumers, who rely more on high or variable-rate credit, would likely feel the most relief. Though we do not expect large moves in rates, declining interest costs on credit cards and auto loans could provide a boost to monthly cash flow.
• Rising real incomes - With the labor market balanced as evidenced by both low levels of firing and hiring, wages should keep rising. Purchasing power could also get a bump as the impact on prices from tariffs fades.

Business Investment

Business spending played a major role in driving growth in 2025, but the pattern was uneven. A handful of technology companies poured extraordinary sums into data centers and advanced computing capacity, with AI-related investment accounting for roughly half of GDP growth in the first half of the year. Outside of AI, however, tariff uncertainty and rising costs caused many businesses to delay or scale back large purchases.

In 2026, business investment should strengthen and become more balanced. Technology will continue to command enormous resources, but the pace of growth will likely moderate after last year’s surge. More importantly, conditions are improving for non-AI investment. Tax incentives in the OBBBA, fading tariff uncertainty, financial deregulation, and easing bank lending standards all point to a broader revival in capital spending.

Smaller firms may also reassert themselves. Small and mid-sized companies have been hit hard over the past few years by high interest rates, rising input prices, and supply-chain disruptions. But improving earnings suggest that capital budgets may expand in 2026, allowing these firms to contribute more meaningfully to economic activity.

Government Spending

Government spending weighed on GDP in 2025 as the Trump administration took dramatic action to reduce the Federal workforce and cut outlays. Additionally, many of the expenditures that survived these efficiency efforts were delayed by the fourth-quarter shutdown. And while state and local governments increased spending, it was not enough to offset federal weakness.

The outlook is somewhat more upbeat for 2026. The first quarter may not only benefit from spending that was postponed during the shutdown, but the federal backdrop looks modestly supportive as well. Most program and staffing cuts appear to be behind us, and defense-related initiatives—such as nuclear modernization, shipbuilding, and munitions restocking—should underpin federal spending. State and local spending, which tends to follow tax-revenue trends, should also inch higher after solid revenue gains in 2025 driven by rising property values. Altogether, government spending in 2026 is likely to be a small but positive contributor to GDP growth.

Trade

The first half of 2025 showed how dramatically swings in the trade deficit can affect the economy. In the first quarter, businesses rushed to import goods before tariffs took effect, pushing imports sharply higher, crowding out domestic spending, and weighing on GDP. Once that surge reversed, growth rebounded strongly in the second quarter.

Compared to that volatility, 2026 should offer a far smoother ride. Although tensions with China persist, the U.S. now appears to have reached a new equilibrium with most trading partners, and large-scale policy changes seem unlikely this year. With fewer tariff-related shocks on the horizon, trade is unlikely to play a major role in shaping GDP growth.

In sum, 2026 is shaping up as a year of steadier, more evenly distributed growth:

• Consumers should benefit from tax relief, potentially lower rates, and rising real incomes.
• Business investment should broaden beyond AI.
• Government spending is poised to shift from a drag to a mild tailwind.
• Trade appears set to recede as a source of volatility.

2026 Employment

As we enter 2026, the labor market is sending mixed signals. On one hand, we see low initial jobless claims and an unemployment rate that points to a healthy environment. Other indicators, however, such as the sharp decline in job growth, appear to paint a more concerning picture. In our opinion, it is the more benign interpretation that is warranted, as much of the deterioration in outright job growth seems to reflect a shrinking labor pool rather than a sharp drop in labor demand – the latter being much more concerning from an economic standpoint.

Two major forces are constraining labor supply. First, the retirement of the baby-boom generation—a trend that has been building for years and likely accelerated recently with the surge in retirement account values—is steadily shrinking the pool of prime labor-force participants. Second, immigration reform under the Trump administration has resulted in not only an abrupt fall in border crossings, but a surge in deportations, essentially eliminating a significant source of workers. Together, these trends have lowered the number of new jobs needed to keep the unemployment rate stable.

That said, demand does have some role to play in the job-growth slowdown. Hiring has slowed marginally, meaning that it is getting more difficult for the unemployed to find a job. Much of this hiring weakness appears rooted in small businesses, which much like the income cohorts we discussed earlier, face a heavier relative burden due to rising costs and rates.

The good news is that the same tailwinds underpinning our economic growth outlook are likely to support labor demand in the year ahead. The accommodative monetary and fiscal conditions should help businesses of all sizes navigate current challenges and keep labor demand broadly aligned with supply, allowing the unemployment rate to remain low in 2026.

Inflation in 2026

The last leg of the Fed’s journey back to its inflation target after the pandemic surge is proving more difficult than anticipated. Every measure of price pressure – from the Fed’s favored Personal Consumption Expenditures (PCE) index to the more commonly cited Consumer Price Index (CPI) – is hovering far above 2%. And instead of the steady progress that was expected heading into 2025, we ended the year at somewhat of a sticky impasse, replete with competing narratives about what sort of inflation truly matters and just what can be done about it.   

And while we caution against needless slicing and dicing of inflation data simply due to how imprecise (even if still useful) the calculations tend to be, we think that the headline and core numbers that dominate the news cycle do hide some useful nuance. More specifically, the current inflation picture may be best understood by looking at three sub-categories: durable goods, shelter, and core services other than shelter.

Durable goods: Tariffs were clearly the major economic story of 2025, and consumer prices were not spared from President Trump’s trade policy leading up to and following Liberation Day. While headline inflation increased only moderately, prices for the types of goods most exposed to international trade – durable goods such as automobiles, electronics, and furniture – surged. And while tariffs are often discussed as one-time price shocks as opposed to lingering inflation drivers, the story is not quite that simple. Overall tariff levels may have peaked, but much of the tax that is passed to the end consumer has been partial and highly variable based on the good in question. Given potential shifts in pass-through as firms continue to adjust to the new trade environment, we could see a prolonged impact on goods prices even without further trade escalation and even if we see the administration dial back trade aggression heading into midterms.

Shelter: The cost of housing is not only the single largest contributor to CPI (less so in PCE, but still a major category), but was a primary reason that overall inflation was modest last year despite surging goods prices (figure 8).  That said, it is difficult to gauge how much more disinflationary progress can be made on this front. Shelter inflation is measured by the oddly named and equally oddly computed Owner’s Equivalent Rent,ⁱⁱ which is only somewhat related to observed housing prices, mortgage costs, or even other measures of rental prices (such as those released by Zillow). And what signals we can discern from leading rent indicators show a flattening in price growth, meaning that we may not be able to rely as heavily on the countervailing impact of shelter disinflation in 2026.ⁱⁱⁱ

Core services (ex-housing and energy): While shelter inflation has fallen slightly and tariffed goods have surged, our last key metric has proven quite stubborn, essentially moving sideways over the past year. Unfortunately, this measure, which strips the impact of housing and energy prices to get around supply impacts, is also the most useful from a forecasting perspective as it tends to be highly persistent. It is also the component of CPI and PCE that is closely aligned with the most important inflation metric from a macroeconomic perspective - wage growth. Additionally, given how heavily this metric is impacted by demand shifts, it is also quite responsive to monetary and fiscal policy. And with a potentially more accommodative Fed and OBBB tax benefits looming, not to mention the recovery in labor demand discussed above, wage growth and core services inflation could prove persistent.

But any inflation discussion would be incomplete without a discussion of expectations. And here we see even more hurdles on the Fed’s path to 2%, as consumer inflation expectations have remained elevated far above pre-pandemic trends (figure 9). That said, longer-term inflation expectations have remained well-anchored despite a year rife with challenges to the Fed’s independence, which tells us that while the consumer may still have some well-warranted doubts about the Fed’s near-term ability to wrangle price pressure, concerns about untethered inflation down the line have not manifested (more on this below).

2026 Fed Policy and Interest Rates

The Federal Reserve spent considerable time in the spotlight last year, but not always for reasons related to its full employment and price stability mandates.   Rather, it was pressure from the White House that dominated economic discourse. 2026 is likely to be more of the same, as the Fed will have to grapple with an economy still marred by trade policy, immigration-related uncertainty, and data dysfunction tied to past (and potentially looming as of this writing) government shutdowns. To add even further complication, we have the small matter of an overhaul of Fed leadership in the middle of the year, as President Trump will finally be able to replace Jerome Powell with a new chairman with one clear instruction: cut rates.

However, while headlines will continue to be filled with predictions and commentary on who will get the job and what it means for the economy, we do not see this as being quite so monumental.

First, it is not obvious that the chair has undue influence over the direction of monetary policy as one voting member among twelve – something driven home by the last Fed meeting of 2025, which saw three dissenting votes for the first time since 2019 (and only the tenth time since 1990). This is as much a reflection on just how difficult it is to parse the current economy as it is on how little groupthink there appears to be on the voting board – an encouraging thought given how much pressure the Fed has been under collectively. 

Second, President Trump and Secretary Bessent have made it quite explicit that they want to see interest rates come down.  But while the public often conflates rates that the Fed controls and those dictated by the market (mortgage rates, for example), it is the latter that seems to be of real interest to the White House.  And while the Fed’s benchmark interest rate (what it pays on reserves) does have an influence on longer-term rates such as the 10-year Treasury yield (and by extension, mortgage rates), this influence is only partial. More impactful, as we saw in September 2024 (figure 10), is what a Fed rate decision signals to the market and how appropriate it is deemed: cut unnecessarily and the market punishment could be swift, sending the 10-year yield higher as inflation expectations rise. This will not be lost on whoever is selected as the next Chair, even if they are closely aligned with the president. This view is supported by well anchored long-term inflation expectations (figure 11).

All of that said, we do acknowledge that even a slightly dovish shift due to a change in Fed leadership could be enough to tip the scales should labor and inflation data prove persistently hazy due to fiscal and trade policy. As such, we still expect one rate cut in 2026 as opposed to the pair currently being priced in by the market. In our view, a strengthening labor market and more persistent inflation will likely take further cuts off the table. However, even if fewer cuts are justified by the economy, it is uncertain how President Trump will react and what pressure may fall on the new Fed Chair in the latter half of the year, especially as we head into the mid-term elections. It is worth remembering that just because President Trump picks them does not mean they will stay in his good graces – recall that Powell was also a Trump appointee.

The impact on long-term yields is slightly more ambiguous. As we mentioned above, the 10-year yield is influenced by Fed rate expectations, meaning that as the market adjusts to the stronger economy, the shift in expectations from two cuts to one should push yields slightly higher.  But these market yields are also heavily impacted by shifts in inflation and growth expectations, while also being subject to demand swings and fiscal pressure. Collectively, given our sticky inflation forecast, robust growth expectations, and (while less important in the short-term) ongoing fiscal problems, it is difficult to see a downward move in the 10-year yield this year. Instead, we expect it to finish in line or slightly higher than current levels.

Stocks in 2026

A favorable backdrop

With a steady-to-lower policy rate and continued expansion, the economic outlook entering 2026 appears supportive for stocks. Historically, stable or declining interest rates have underpinned valuations while growth has boosted corporate earnings, providing a robust tailwind for equity prices. Specifically, since 1970, the average return for U.S. stocks as gauged by the S&P 500 in years characterized by both accommodative or steady policy rates and an economy that is neither in a recession nor immediately following one is 20% (compared to the 12.5% average return for all years in the same period).

We also expect solid earnings trends to continue lifting share prices outside the S&P 500. After a profits recession in 2023, earnings growth has reaccelerated across regions, supporting broad-based global equity market gains.

Emerging Markets: Like the S&P 500, emerging markets have benefited from a sharp rebound in corporate profits, led by large technology companies in Asia and supported by strong results from precious-metals producers in South Africa and banks in India. These earnings gains helped fuel outsized equity returns in 2025, as improving balance sheets and expanding margins reinforced investor confidence. Looking ahead, continued solid economic growth across many emerging economies—along with favorable financial conditions and resilient domestic demand—should help sustain healthy earnings increases and support equity market momentum in 2026.

Developed International Markets: The earnings recovery in foreign developed markets has lagged that of the U.S. and emerging markets, reflecting more limited exposure to fast-growing technology companies and softer domestic economic conditions. Even so, equities in this segment outperformed the S&P 500 in 2025, buoyed by optimism surrounding a prospective fiscal shift in Europe, expectations for economic revitalization under new leadership in Japan, and a weaker U.S. dollar. However, we do not expect similar tailwinds to emerge this year. With only moderate earnings growth and somewhat more restrictive monetary policy compared to the U.S., developed international markets may struggle to keep pace with other segments of the global stock market.

Small and Mid-Caps: Profits of small- and mid-sized U.S. companies have been slower to recover, reflecting ongoing pressure from elevated post-pandemic input costs and the added burden of higher tariffs. Even so, earnings growth turned positive in 2025, and easing margin pressures in 2026 should allow that momentum to build. As the earnings gap between large companies and their smaller counterparts narrows, we expect returns to converge as well.

The First Command Investment Philosophy

 At First Command, we value time in the market versus attempting to time the market. We accept volatility as an inherent cost for stock investors and use it to our advantage to potentially improve market returns through the use of globally allocated, well-diversified portfolios.

Additionally, given that market declines are inevitable, as figure 15 makes quite clear, our Advisors are trained to utilize the wide range of investment options we offer to ensure that our clients’ investments are aligned with their financial plan and, just as importantly, to keep them on plan and on track through such periods.

If you haven’t met with your Financial Advisor recently to review your plan, we encourage you reach out to make sure you’re well-positioned for whatever this year may bring.

Thank you for the confidence you have placed in First Command.

ⁱThe key WWII conferences held by Roosevelt, Churchill, and Stalin to decide on the framework for post-war Europe that clearly highlighted the tensions inherent in a polarized world and set the stage for decades of U.S.-Russia - and similarly, U.S.-China - conflict.
ⁱⁱhttps://www.bls.gov/cpi/factsheets/owners-equivalent-rent-and-rent.htm
ⁱⁱⁱhttps://en.macromicro.me/collections/5/us-price-relative/49740/us-cpi-rent-zillow-rent-yoy

The information in this report was prepared by John Weitzer, CFA, Chief Investment Officer, Matt Wiley, CFA, Senior Vice President, Deputy Chief Investment Officer, Dan Murphy, CFA, Investment Strategist, and Matt Conner, Senior Investment Consultant of First Command. Opinions represent First Command’s opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual advisor. All statistics quoted are as of the date of this publication, unless otherwise noted. First Command does not undertake to advise you of any change in its opinions or the information contained in this report. This report is not intended to be a client specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Should you require investment advice, please consult with your financial advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes and other costs.

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