The Decisive | Season 4 Ep.19 - Top 10 Insights Shaping the 2026 Economic Outlook

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Kristen Hallam:

You’re listening to The Decisive Podcast. Insights and analysis to empower confident decision making. Hello and welcome to The Decisive Podcast. I'm your host, Kristen Hallam. For our final episode of 2025, we bring you an excerpt from our recent client webinar unveiling our top 10 economic insights for 2026. The Decisive will take a winter break until January 10th, when we will return for season five. We wish you all a happy and healthy start to 2026. And now on to this week's episode.

The economic outlook for the coming year is characterized by a delicate balance between emerging tailwinds and persistent headwinds. Moderating inflation and looser fiscal policies in major economies will support growth. Elevated debt burdens and the specter of renewed inflationary pressures pose constraints on fiscal and monetary policy. In this environment, we expect emerging markets and frontier economies will experience varied trajectories.

To provide you with our top 10 economic insights for 2026, we have the following experts from S&P Global Market Intelligence Ken Wattret, Vice President, Global Economics; Ben Herzon, Executive Director and Co-Head of US Economics; Hanna Luchnikava-Schorsch, Associate Director and Head of Asia Pacific Economics; and Thea Fourie, Head of Middle east and Africa Insights and Analysis. Ken, let's set the scene. One of our key themes for 2026 is shaky economic foundations. What do we mean by that, and how do we expect that theme to show up in 2026?

Ken Wattret:

Hello, Kristen. Hi everybody. Well, we've been highlighting for some time that many of the economic and financial anchors that we became accustomed to have become more uncertain and unstable. That's been most obvious this year in relation to trade and tariffs, but it also applies to the uncertainty surrounding lots of other economic issues. Inflation prospects, the outlook for monetary policy, the public finances, bond yields. It's a pretty long list. The high level of uncertainty has weighed on economic activity this year. We expect that will continue in 2026.

Also, if uncertainty is unusually high, we as forecasters need to think more about the risks surrounding our projections and their potential consequences, not just the base case. And thankfully, we have the benefit of being able to run alternative economic scenarios through our global link model. That's a very helpful tool in these uncertain circumstances.

Kristen Hallam:

Thanks, Ken. So, with that context in mind, let's get into our top 10 insights for 2026. First, we're expecting the US to avoid a recession. What tailwinds do we see that are supporting that view, Ben?

Ben Herzon:

Thanks, Kristen. Well, there are a few tailwinds supporting growth in the US outlook. First, are our visions of the recently passed budget bill or the One Big Beautiful Bill Act. The legislation includes a personal tax cut, a portion of which is direct or active to 2025. So not only will personal tax withholdings decline at the beginning of 2026, but households will receive elevated refunds in the first half of the year. This will provide a boost to consumer spending next year. This is a tailwind. The legislation also includes increases in federal spending on national defense and border security. That's another tailwind as well.

We also look for some support to housing markets from a narrowing mortgage spread. This is a spread between mortgage rates and the 10-year treasury yield. This spread has been elevated in recent years relative to historical norms. As longer term treasury yields ease in our forecast, mortgage rates will ease by more as this spread continues to narrow. To be clear, we do not have a robust outlook for housing starts, but it would be weaker were it not for this narrowing mortgage spread. So that's a tailwind. In addition, from the perspective of our forecasting model, inventories at the end of this year in the aggregate would be lean. And this will provide an incentive for businesses to pick up the pace of production to rebuild inventories.

And finally, in the tailwinds category, tariffs have made imports expensive. So as long as tariffs remain elevated, this will redirect domestic demand away from foreign suppliers to domestic producers where close substitutes and capacity are available.

Kristen Hallam:

Thanks Ben. And what headwinds are working against those tailwinds to arrive at near potential growth for the US economy? Ben, do we expect a delicate balance between these headwinds and tailwinds?

Ben Herzon:

Yes, yes we do. Since we were just discussing tariffs, let's stay on that topic. While tariffs will indeed support some areas of the economy, they will act as a headwind to other areas. So let's talk through this. Tariffs are giving rise to inflation. This is keeping Fed policy tighter and interest rates generally higher than they otherwise would have been. This is weighing on interest sensitive areas of the economy and taking a longer view like from before the tariffs were in place, real borrowing costs have risen sharply over the last few years and are currently among the highest levels going back 15 years. So this combined with a still elevated uncertainty surrounding trade policy will weigh on business fixed investment.

Also, unusually sanguine attitudes about taking on risk have kept credit spreads in corporate debt markets and the risk premium in equity markets low. In our forecast, we assume both of these measures rise toward their historical norms. So what this means is so widening credit spreads will prop up the corporate borrowing costs and weigh on investment spending and a rising equity risk premium is expected to contribute to roughly a 12% decline in equity values in our forecast. This will weigh on consumer spending.

Kristen Hallam:

Thanks, Ben. Ken, coming back to you to talk about our next insight involving Western Europe. We're predicting that growth rates in this region will stay subdued with more positive prospects for domestic demand. What is driving those demand prospects and where are they likely to be most pronounced?

Ken Wattret:

To answer the second part of the question first, the focal point really is Germany and the sea change in its approach to fiscal policy. The government announced an unusually large package of fiscal measures back in March focused on infrastructure and defense expenditure. Those measures are forecast to contribute to faster domestic demand growth in Germany in 2026 and also in subsequent years, albeit from a relatively low base, with the German economy having really struggled in recent years. Now, as Germany's the biggest economy in Europe, the fiscal boost is expected to have some positive spillovers to the rest of the region. And more generally for Western Europe, we're expecting that domestic demand will gain some support from a series of other developments. Those include resilient labor market conditions in most countries, further moderations in consumer price inflation rates supporting household real incomes, and the lagged effects of more accommodative monetary policies filtering through. Now, of course, we're talking about Europe here, so inevitably there are some potential problems.

One for Germany is its high export share in GDP and also its comparatively large automotive sector. They leave the economy relatively exposed to less favorable trade conditions, particularly with the US and what we expect will be relatively subdued global growth. More broadly, we're expecting net trade to drag on economic growth rates in 2026 in various parts of the region, again due to a combination of factors. They include stronger currencies, higher tariffs on exports to the US and also a loss of market share to mainland China and in mainland China. Other headwinds to growth that we also have to think about include fiscal consolidation in two of the regions or the largest economies, France and the UK and putting all this together, net, we're projecting that 2026 will see an annual real GDP growth rate for Western Europe slightly below 2025's estimate of around one and a half percent.

Kristen Hallam:

Great. Thank you, Ken. Now, domestic demand is also a theme for the world's second biggest economy, mainland China. Which brings us to our next insight. China has been exporting what its domestic markets are not consuming. But with shifts in tariff policy and trade patterns, what does it all mean for mainland China's economy, Hanna?

Hanna Luchnikava-Schorsch:

Thanks, Kristen. Indeed, China's economy did better than anticipated to 2025 so far. In fact, we have been adjusting our forecasts upwards throughout the year and now anticipating that the government's target of 5% is likely to be reached this year and the real GDP growth will be 4.6% next year, which is above what we were expecting back in April. And part of the reason, or one of the key reasons why Chinese economy has been more resilient is its export story. In fact, despite the US tariffs, merchandise exports were more resilient and grew at above 6% in the first three quarters. And that was partly attributed to the frontloading of exports in the earlier part of the year. But then it also is attributed to China's rising share in global trade more generally. If we look at China's share of exports outside of the US, we can see that its exports of goods in in regions, particularly in emerging economies, has risen over the past two years and this year in particular. In fact, as China's merchandise exports to the US have fallen by 18% year on year in the first 10 months of the year, it has risen by double digits to the regions such as ASEAN, Africa and Latin America.

In fact, for Africa, the share of China's exports to the region has risen from only about 24% last year to nearly 29% in the first half of 2025. So in that sense, exports have been more resilient, contributing to greater economic strengths. But that is not to say that exports will not slow. In fact, we do expect less favorable base effects and slowing external demand to contribute to a slowdown in exports next year. And that means that China will have to rely more on domestic demand for growth, with the authorities deploying more stimulus in the form of interest rate cuts, fiscal measures as well as enhanced industrial policies to make domestic demand a key contributor of economic growth in 2026. In fact, we do expect the government to increase its fiscal spending, which will lead to greater fiscal deficit and general government debt and that spending will be channeled towards consumption support, particularly of services. Government investment will pivot from industries with oversupply to infrastructure and innovative industries like artificial intelligence, quantum technology and aerospace. And this will not fully alleviate, but it will ease some of the supply demand imbalances which persist in China's economy, contributing to more resilient growth.

And lastly, the property sector downturn. Even though it is expected to persist, its impact on the economy will diminish as the share of housing and construction in overall GDP is going to be less than it was a year ago. So again, overall, our expectation for China is we still anticipate a slowdown, but the key risk factors that would otherwise have led to a more pronounced downturn have diminished, with growth likely to hover just under 5% with authorities deploying the stimulus needed to keep it afloat.

Kristen Hallam:

Right, now, staying with you, Hanna, and moving on to our fourth insight for 2026. India will remain the world's fastest growing large economy. How is India's economy managing that feat as tariff headwinds grow?

Hanna Luchnikava-Schorsch:

So, India is ending 2025 with one of the world's highest US tariff rates of 50%. It is also looking increasingly likely that it will start 2026 without the trade agreement with the US, which we still anticipate both parts to be interested in concluding this agreement. And we expect that the tariff rate on India will be reduced to something closer to the regional average of about 20%. But so far as tariffs persist, they already are taking effect on industries directly exposed to US exports, including textiles, chemicals. They are also leaving investors uneasy with large capital outflows registered so far in 2025, Indian rupee

weakening and merchandise trade deficit widening. On the other hand, domestic economy, which is the pillar of growth for India, is doing better. Some of the measures which the government have introduced this year, including income tax reductions early in the year and more recently the rationalization and reduction in goods and services tax, as well as easing inflation because of a good monsoon season this year, are contributing to an acceleration in consumer spending and also indirectly to private investment, which is directed to domestic investment. And all of this is mitigating the impacts of US tariffs.

As we move into 2026, the tailwinds from these measures, including fiscal support as well as monetary policy support, are likely to mitigate the effects of US tariffs. But growth will still slow nonetheless, with our current expectation of GDP slowing to 6.2% next year from about 6.5% during the current year.

Kristen Hallam:

Thank you, Hanna. Thea, let's bring you in to talk about emerging economies and our next insight. We expect that aggregate growth in developing economies like Kenya will outperform that in the larger emerging economies like Brazil. What are the main drivers of that, Thea?

Thea Fourie:

Yeah, thank you for that question, Kristen. Absolutely. It is our view that for next year, 2026, developing markets growth rates in aggregate will catch up with that of emerging markets. But I think before we go into more detail into this, let's just focus very briefly on the emerging market outlook for next year. We do expect a marginal slowdown in the overall emerging market growth. I think Hanna provided some very important detail in what we expect for the Asian Pacific region where China and India is of course big contributors. So that region is going to be to some extent a drag on emerging market growth. But also for Latin America we expect very soft growth next year, which is almost unchanged from the outlook for this year.

For Latin America, this is one of the regions that is really experiencing impact on slower exports due to the US tariffs similar to other regions in the world. We do expect that domestic demand will provide some support to this economy as inflation slows and interest rates continue to fall next year in Latin America. Very limited fiscal space to support economic activity in some of the largest economies in Latin America, particularly Brazil. And this will also be a drag on the overall growth story for this region. Favorable

prospects for Europe, emerging Europe, where we see growth ticking up marginally next year supported by domestic demand but also rising credit growth that will support export fixed investment spending. For the Middle east and North African region, very dependent on oil exports, of course. We expect lower oil prices, but this will be offset by resilient oil production levels and of course also the programs that continues to diversify these economies. So non-oil GDP will do well. And then getting back to your questions about developing markets, a lot of those developing markets in the sub-Saharan African region, and this is a region that we still see economic growth to be quite resilient next year, in fact much higher than what we've seen in previous years.

This region will find support from robust domestic household spending, which is a reflection of lower inflation, lower interest rates. And it's also one of those regions that's less exposed to the US tariffs given the fact that the US account only for a small margin of their overall trade profile. So this is helping the developing markets next year to sustain their growth outlooks.

Kristen Hallam:

Thank you, Thea. Domestic demand seems to be a bit of a theme here. Could you tell us how we see tariffs and more restrictive trade policies impacting emerging markets, Thea?

Thea Fourie:

Yes, again one of those regions that we do see a lot of impact of the tariffs, particularly from the US is in Latin America, which has been a huge drag on overall economic activity. But I also think it's interesting to highlight those Asian countries outside of mainland China where we still also see quite robust export prospects for next year. And this is really due to the type of products that these economies export very much on the, on the industries that is attracting a lot of investment and investor focus. So it's your electronics, your AI related type of products like your chips and those things. So a lot of uncertainty in this outlook, but we will get to that later in the conversation. But those type of products is supporting industrial production as well as, as well as exports for these Asian outside of China. Also for countries like sub Saharan Africa, which is part of those developing markets, we still see robust exports coming from mineral exports and also rare earth exports supporting those markets as well.

Kristen Hallam:

Thank you, Thea. Moving on to our next insight, which is about artificial intelligence. We see AI as both a positive and a negative risk to 2026's growth outlook. How do we view it as a positive? Using the U.S. economy as an example, Ben.

Ben Herzon:

Yeah, so we have seen rapid growth of investment spending in areas related to AI. For example, spending on intellectual property products, which includes spending on research and development and software. These are AI categories. Spending surged in the first half of 2025 and contributed an average of 0.6 of a percentage point to annualized GP growth during the first half. Now our forecast assumes that growth of spending on this category of investment slows. It might not slow. So if it doesn't slow, that would raise our forecast of GDP growth. So, so that's how a view of spending on AI as a, as an upside risk to the outlook.

Kristen Hallam:

Thanks for that, Ben. And Ken, let's bring you in to talk about how we see AI as potentially negative. Could you give us some color on that?

Ken Wattret:

Yeah, absolutely. The obvious concern there is correction in elevated equity prices. And if that correction was to be large enough, that could have material adverse effects on demand across the global economy through a multitude of channels, including negative household wealth effects as equity prices come down, damage to business confidence, less favorable financing conditions, and so on. And an obvious reference point in this regard is what we saw in the early 2000s after the bursting of the dot com bubble. We recently published some analysis on that period. There were a few key takeaways from that course of events that we should highlight. First and foremost, we had boom conditions in the US economy, which ground to a halt after the crash. And secondly, although a technical recession in the US was averted at the time, just helped by large scale fiscal and monetary stimulus, we did see contractions in US exports and investment nonetheless.

And third, although there were significant variations in the economic effects of the bursting of the dot com bubble at country and regional level, in general, growth rates in the major

economies took a significant hit. Now, that hit was less in terms of scale and duration than during the global financial crisis, but it was a material shift nonetheless. It's also important to highlight that there are some differences in the circumstances in the late 1990s and early 2000s compared to those currently, some good, some bad. On the positive side, the major tech companies that have seen their valuations rise in the recent period are generally mature businesses and profitable. The traditional valuation metrics for those companies also look less elevated at present, and that suggests that the potential for a major correction in equity prices, the likes of what we saw in the early 2000s, is lower currently. But at the same time, though, we have economic conditions, as we've talked about in many regions and countries which are relatively fragile, that leaves them more susceptible potentially to being tipped into recession. And also, and this is really important point, the policy space available to respond to adverse shocks is much more constrained this time around. So look, there's lots to digest there, I understand, but in summary, I'd say the circumstances differ currently to those in the late 90s and early 2000s, but there are potentially some grounds for concern.

Kristen Hallam:

Now we've hardly mentioned the word inflation, even though we've just seen the greatest escalation of tariffs in over a century. Our next insight touches on one factor in moderating inflation, declines in crude oil prices. Ken, tell us more.

Ken Wattret:

Yeah, I guess the starting point here is that oil prices can have a significant influence on inflation rates because typically energy is a big chunk of the consumer price index in most economies. Now, our colleagues in S&P Global Energy believe that a combination of rising crude oil output and modest demand growth will see a marked increase in the global crude oil supply surplus in the period ahead. They expect that will push dated Brent prices below $60 a barrel and keep them there in the early part of 2026. We're assuming an annual average Brent price of below $60 a barrel next year, compared to around $70 a barrel on average in 2025. Now, that's an important downward pressure on headline inflation, particularly for emerging economies, as they generally have relatively high weights for energy prices in their consumer price indices. And that's a key element of our forecast of somewhat lower annual consumer price inflation rates in 2026 in most economies. But there are some exceptions which I think we'll come to shortly. We also need to highlight though, that underlying inflation rates, core inflation rates, so excluding food and energy

prices, typically they've been quite elevated in some of the larger advanced economies since early 2025.

That's partly due to higher goods inflation, particularly that's the case in the US Related to some tariff effects, but it's also due to a stalling of the post pandemic downward trend in services inflation rates. And those inflation rates typically have a higher weighting than core goods in most advanced economies. Now our base case is that we'll see a moderation of services inflation rates resuming in 2026. If we're wrong on that and it doesn't happen, then that might be a constraint on monetary policy easing and growth.

Kristen Hallam:

Thanks, Ken. And you're right, we are going to talk about some exceptions to this outlook for moderating inflation, namely the U.S. india and mainland China. Ben, let's hear from you first about our inflation expectations for the US, and then Hanna will come to you for India and mainland China.

Ben Herzon:

Sounds like a plan. Okay, so for the US, the near-term outlook for inflation is all about tariffs. And the narrative has been that tariffs have been slow to pass through to consumer prices. Now we think we know why this is the case and we think that the factors that are limiting the pass-through of tariffs to consumer prices are temporary. For example, earlier this year businesses stockpiled imported commodities ahead of tariffs so that they could sell and use these commodities at pre-tariff prices. This has delayed a tariff-induced price gains, but eventually these inventories will run out and businesses will be forced to sell and use imported commodities at higher prices, that is, prices that reflect tariffs. Also, the actual tariff rate has lagged behind the rate that most analysts, including us, expected based on reported tariff rates.

Businesses appear to be importing lower tariffed commodities and delaying the import of higher tariffed commodities. And this is limiting tariff costs and hence inflation pressures for now. But to maintain existing production processes, businesses will eventually have to import higher tariffed commodities. So we should see these price pressures pushing through. And finally, we do believe that businesses are absorbing some tariff costs and profit margins, perhaps in hopes that tariffs will eventually be reduced. But the longer that tariffs remain high, the less willing businesses will be to continue this practice and they will eventually pass through tariffs to prices. As a result of all of these factors, we expect tariffs

to continue to pass through to consumer prices over the next several months. And in our forecast, we show core PCE inflation continuing to rise and reaching a peak at 3.3% in the second quarter of next year.

Kristen Hallam:

Thanks, Ben. And over to you, Hanna.

Hanna Luchnikava-Schorsch:

Thanks, Kristen. So I know India and China were singled out here, which I think technically is correct because we will see inflation in both of these economies going up compared to 2025. But in all fairness, it will be from a very low base and for different reasons in both of them. So for China, again, the key issue here is persistent supply and demand imbalance and oversupply. The government's efforts to reduce oversupply and restore corporate profitability in what it's called its anti-involution campaign should help alleviate to a certain extent this imbalance and to reduce deflationary pressures. Again to an extent, we do anticipate consumer price inflation to rise to 0.5% on average in 2026 and produce the prices to come out of deflation sometimes during the third quarter of the next year as a result. In India, what we are seeing currently, is that inflation rates again have reached historic lows with inflation, in October, consumer price inflation registered at only 0.3% year on year.

And this is primarily because of a decline in food prices, which again is unprecedented. Partly this is an effect of two consecutive good monsoons, which boosted food supply. It is also related to the latest government's reduction in goods and services tax which I already mentioned earlier. As we move into the next year, we will see less favorable base effects pushing prices up. One of the factors which Ken also mentioned is energy prices. And there we still expect favorable contribution to India's inflation where energy prices are expected to remain moderate and keep prices contained. As a result of which our average inflation projection for India currently stands at about 4.5% which is within the central bank's target range, allowing the central bank to continue with its monetary policies.

Kristen Hallam:

Thank you. Our next insight is that many central banks have further to go in their easing cycles, speaking of monetary policy. Ben, what about the Fed? What are we expecting from them in 2026?

Ben Herzon:

Yeah, so our current call is that the Fed will cut the federal Funds rate by 25 basis points at its meeting next week. This, though, is a close call. If the Fed does ease, this will leave the target range still 50 basis points above our estimate of the long run neutral range. So there would be some range. So there would be some more easing to go. But with inflation rising early next year, we expect the Fed to again pause its rate cuts until the June meeting at which point, you know, the peak of tariff-induced inflation will have passed. And we expect the Fed at that point to be to resume easing. And we have the Fed lowering the federal funds rate to the neutral range of three to three and a quarter by next September.

Kristen Hallam:

Thanks, Ben. So naturally the scope for rate cuts varies considerably across central banks. Ken, where are we likely to see the biggest rate cuts and where will we see more moderate easing?

Ken Wattret:

Well, as you've rightly highlighted, Kristen, monetary policy prospects have been quite divergent for a number of reasons. Differing inflation trends, variations in growth and exchange rate dynamics, differences in central bank targets and mandates, and so on. But long story short, we think that the scope for rate cuts is largest from the central banks which have pursued the most defensive monetary policies during 2025. That includes Brazil, Turkey and Russia. The latter two have already embarked on their easing cycles, albeit from rather restrictive levels. In contrast, there's less scope for rate cuts in the economies where central banks have been front running the Fed's easing cycle and unusually, that includes the European Central Bank. Typically, what the Fed does, the ECB follows with a short lag.

But in this case, it's been different and that's because inflation in the euro area has been lower. Economic conditions also been softer, and as a consequence the ECB has been cutting rates ahead of the Fed. Our conclusion, given where we are in terms of the inflation

and growth outlook, is that the ECB is probably done easing and that then has a knock-on effect on other central banks in the region. Many of those shadow what the ECB does. So that means in Western Europe there is some limits to the scope for easing. Although for the Bank of England, for example, which has been very cautious because of high UK inflation, we still expect to see a continuation of the gradual rate cuts we've seen. There are also some anomalies of course, rates going higher in some economies, notably in Japan, where we expect the BOJ will continue its gradual tightening track.

Kristen Hallam:

Thank you, Ken. So our next insight involves the US dollar. So the US dollar's depreciating trend is expected to resume. Ben, what is driving that expectation?

Ben Herzon:

There are a couple things going on here. First, over the last few years, the dollar has traded above a level that our model views as consistent with the underlying fundamental determinants of the dollar. And those determinants are the ratio of domestic foreign prices, current account balance and the interest rate differential between US and foreign sovereign yields. The weakening of the dollar over the first half of this year simply realigned the dollar on the prediction from that model, so essentially lined it up on the fundamental drivers. Now, because this depreciation over the first half this year was not explained by the terms in our model, that is the change in the dollar, the depreciation that was not explained, it could have reflected some erosion of the dollar's exorbitant privilege. It’s hard to know for sure, but that could have been what was going on over the first half of this year. Going forward, as U.S. Treasury yields ease, the differential between U.S. and foreign sovereign yields narrows in our forecast, and this pulls the US dollar even lower over the next few years.

Kristen Hallam:

Thank you, Ben. We also expect significant variations in key bilateral exchange rates. Can you give us some more details on that?

Ken Wattret:

Yeah, absolutely. Again, the outlook varies because there are a whole host of differences that, you know, drive exchange rates, economic conditions, interest rate differentials, external imbalances, currency pegs. Again, it's a pretty long list. If we look initially at the handful of advanced economy currencies which have the highest weights in the US dollar index, then we're expecting most of those will appreciate against the dollar during 2026, albeit with some variations in orders of magnitude. The yen is forecast to outperform, consistent with monetary policy divergence versus the US. We're expecting relatively modest depreciations of the euro and UK pound that we're expecting their domestic economic, fiscal and political difficulties to continue. If we then think about emerging economy currencies versus the dollar, the picture's a bit more divergent there, again reflecting differences in the fundamental drivers of those currencies. Of those with the highest weights in the dollar index, again, the forecast outperformers include the Brazilian real, which we still consider to be somewhat undervalued, and some emerging European currencies. Expected underperformers include some of those already mentioned where we expect to see central banks cut their policy rates the most, for example, Russia and Turkey.

Kristen Hallam:

Thanks, Ken. Thea, how will the US dollar depreciation impact emerging markets?

Thea Fourie:

Yeah. So, Kristen, dollar weakness, as Ken mentioned, can have advantages for some emerging market currencies. They should be a bit more resilient against the weaker US dollar. And ultimately that could be supportive of the inflation outlook for particularly those countries that are oil importers because that import bill becomes less expensive because their local currencies are much stronger. But then also for a lot of emerging markets, and particularly also developing markets, a stronger local currency also improves the debt servicing cost outlook for next year because over the period 2022, up until 2024, when we had a very strong dollar, we saw quite a big spike in the external debt servicing cost for a lot of emerging markets as well as developing economies. And that forced some of those countries that experience debt distress to ask for debt restructuring. So a weaker dollar will bring down that debt servicing obligation next year and will also support their fiscal finances.

Kristen Hallam:

Thank you, Thea. And now we've come to our last insight for 2026. The trend of steepening sovereign yield curves will resume. This is something we called out last year amid high levels of public debt, and looser fiscal policy has also been a theme for today. Ken, why are we so concerned with the poor state of these fiscal metrics? And what are you monitoring to gauge whether the situation is improving or deteriorating?

Ken Wattret:

Well, there are a lot of reasons why we're worried about fiscal fragilities, which I'll come to in a second. But just first of all, I think it's important to point out that we are expecting moderating inflation and lower central bank policy rates to lean down on sovereign bond yields in some parts of the world, including marginally in the US during 2026. What we're emphasizing, though, at the same time is that investors are going to continue to demand a significant risk premium to hold longer dated sovereign bonds, given the parlous state of the public finances in so many of the world's largest economies. Now, we've been characterizing the public finances in those economies as an unstable cocktail of various worries: persistent very large budget deficits, already very elevated debt to GDP ratios, deteriorating relative prospects for nominal growth and interest rates, and political obstacles to effective fiscal consolidation. And you put those together and that means that there's an ongoing risk of upward pressure on yields. And if we were to see a major move upwards in sovereign yields, then that would pressure governments into having to respond with pro-cyclical fiscal adjustments. In other words, they're cutting spending or more likely raising taxes at the same time as economic conditions are deteriorating. And in that kind of scenario, it's quite likely that we would have recessions in many economies.

In terms of what we're monitoring, we look across a wide range of metrics, all the obvious things that have already been mentioned, plus some others, primary budget balances, for example, which excludes debt interest payments; net debt ratios, which in most economies are a bit less worrisome than the gross measure; average debt maturities, for example, which mean the rollover risk is somewhat reduced. But the key metric for debt sustainability over the medium to longer run is one that I already mentioned, the relationship between nominal yields and nominal growth rates. And that is much less favorable since the pandemic and likely to stay that way because we've got already high debt burdens, much higher yields than we had going into the pandemic, and poor demographics leaning down on nominal growth. So that is going to remain a big issue going forward. The question that normally follows all this is: Which of the countries most at risk? We would certainly characterize the U.S. public finances as being on quite a disturbing trajectory, but the dollar's reserve currency status is a source of support. The UK looks

relatively vulnerable and as we again highlighted in a recent analysis, its problems are deep rooted, including a reliance on foreign investors to finance a persistent large current account deficit. A few of the highly indebted eurozone member states also look vulnerable, although their yields are currently a lot lower than those in the UK and they have less typically external imbalances.

And then there's Japan. We've got 30-year JGB yields which were close to zero going into the pandemic, which are now well above 3% and on a very clear upward trend. That's been a very radical change there.

Kristen Hallam:

Thank you, Ken. Global growth proved to be more resilient than expected to rising tariffs and uncertainty in most of 2025. Could the same happen again?

Ken Wattret:

Yes, it could. I think it's important to point out that our growth forecasts are not so pessimistic. As mentioned at the beginning, we're not looking at a recession in our view in the US. We're seeing growth rates being subdued by various headwinds. This is by no means a pessimistic scenario, but I understand typically economists have a tendency to think about downside risk and often underplay upside risks. There are some upside risks that we need to think about. We already mentioned one of those, possibility of continued strength in AI-related expenditures. And there are a few others as well. If we see trade agreements with the US continue to progress, for example, tariffs could come down, uncertainty would recede.

That might raise the propensity of households to consume and businesses to invest. If we get downward surprises on inflation, both headline and core rates, we could see faster, deeper falls in short and long term interest rates than we are currently forecasting. May take a while for the impact of that on economic activity to filter through, but that's also a potential upside risk. And linked to that, much lower interest rates would ease some of those fiscal concerns that we flagged. So we're cognizant of the risks and both upside and downside. We'll continue to closely monitor all of them.

Kristen Hallam:

And that's all the time we have for today. So thanks to Ken, Ben, Hanna and Thea, and thanks to you all for engaging with us. Until next time. Thank you for listening to the Decisive Podcast from S&P Global. Please subscribe and join us for next week's episode. Until then, stay curious and stay informed.