The environment we enter in 2026 is defined by collision, between policy and markets, supply and demand, confidence and positioning. Forces that once moved in parallel are now working at cross-purposes, increasing dispersion and raising the cost of being wrong.
Inflation has retreated meaningfully from prior peaks, though remains stubborn in its final descent to the Fed’s target. The labor market, once the bedrock of economic resilience, has lost some of its footing at the headline level, while Corporate America is regaining confidence after a year spent trudging through policy shifts and tariff uncertainty. Much of that uncertainty was front-loaded into 2025, and the dust is beginning to settle following “Liberation Day.”
What remains is an environment that demands discipline, preparation, and a steady hand. Outcomes will be shaped less by broad direction and more by sequencing, speed, policy transmission, and capital allocation decisions. In this environment, fixed income increasingly functions as collision protection, not by avoiding risk, but by shaping where, when, and how risk is realized.
Understanding the year ahead is less about following a rulebook and more about navigating a game where the rules and stakes shift mid-move. Policy signals change, incentives reset, and market reactions rarely wait for clarity. Even in our internal framing, we have begun to look beyond what has already been done towards what actions are likely to be taken in the future, a nod to understanding the goals and directives of the current administration. While this exercise has been instructive of the direction of travel, we are cognizant of the fact that multiple policy paths can materialize, often in unexpected combinations.
Yield Curve, Term Premia, and Market Positioning
Rates are the primary transmission mechanism through which policy, supply, and confidence are expressed in 2026, and they must be addressed first.
Consensus expects 2026 to be relatively stable, with real growth near 2%, inflation around 3% in the first half before moderating, and a steeper yield curve driven by expectations for Federal Reserve policy normalization. We also expect a steeper curve, but why it steepens matters more than the steepening itself.
In our view, curve steepening is driven primarily by rising term premia rather than aggressive front-end rate cuts. While front-end yields may ease as the Federal Reserve normalizes policy, the dominant force is pressure at the long end, reflecting stronger growth, rising debt issuance, and elevated political and geopolitical uncertainty.
This dynamic is already embedded in market positioning. Expectations for a steeper curve have produced a sizable short base in long-duration instruments, introducing meaningful asymmetry: upward pressure on yields tends to build gradually, while downside moves can be abrupt as positioning adjusts. As a result, the long end becomes increasingly sensitive to shifts in confidence, policy execution, or geopolitical risk.
Flight-to-quality dynamics can emerge even in the absence of recession risk, producing sharp but temporary declines in long-end yields. Such moves would be driven by positioning and confidence shocks rather than any deterioration in the underlying growth or inflation backdrop.
A building short base in the iShares 20+ Year Treasury Bond ETF (TLT) doesn’t necessarily reflect true overall market positioning, but it can be indicative in a directional consensus view building against US Treasury duration. As exposure concentrates in these vehicles, volatility increases and price behavior can become increasingly reflexive, driven by flows and shifts in sentiment rather than underlying fundamentals. In this environment, long-end duration is best treated as a tactical, range-bound tool, used selectively, rather than a long-term conviction exposure.
The Federal Reserve: Neutral Is the Goal, Credibility Is the Constraint
The Federal Reserve remains focused on moving policy toward a neutral stance. While this responsibility rests with the Fed rather than the administration, policy execution has become increasingly constrained by public pressure, heightened market sensitivity, and the need to maintain credibility. As a result, the timing, pace, and communication of policy decisions now carry outsized market consequences. Given the fact that continued Fed easing is a fundamental view expressed within the consensus for curve steepening, understanding how the dynamics shaping the Fed’s reaction function this year will be crucial.
2026 will be a consequential year for the Federal Reserve from a governance and composition standpoint, but the risk of abrupt policy reversal is likely overstated. While attention has focused on potential leadership changes and questions around central bank independence, U.S. monetary policy is determined by a committee, not a single individual. The structure of the Federal Open Market Committee (FOMC) inherently limits the ability of any single individual to unilaterally redirect policy.
That institutional design matters. Continuity is not accidental, it is a feature of the system. Chair Powell retains a separate 14-year term as a Governor that extends through 2028, and history offers precedent for maintaining stability through leadership transitions. In 1948, Marriner Eccles remained on the Board specifically to preserve institutional continuity. A similar outcome would meaningfully constrain the scope for abrupt policy shifts, even in the event of a change in leadership. While unprecedented in historical contexts, it is important to note as well that the chairman of the Federal Reserve Board of Governors is nominated by the president, but the chairman of the committee that determines monetary policy is selected by the internal FOMC. If a situation were to arise where the presidentially elected chairman of the Federal Reserve didn’t demonstrate independence necessary for the FOMC to best conduct policy transmission, checks and balances are in place to limit a politically driven Fed chair.
Procedural and legal considerations surrounding existing Governors further reinforce this constraint. Unless multiple seats turn over simultaneously, changes in the balance of views occur gradually, not instantaneously. The more likely outcome is a slow evolution in tone and emphasis, rather than a sharp inflection in policy direction.
For markets, this framework argues for dispersion rather than systemic risk. Policy outcomes become more sensitive to communication, sequencing, and interpretation of incoming data rather than wholesale shifts in reaction function. In a market already positioned for easing, credibility and messaging may shape volatility around rates, even as fundamentals ultimately assert themselves.
Inflation: Progress, Timing, and Conditionality
Inflation in 2026 reflects the interplay of offsetting forces rather than a single trend. While progress continues, it remains uneven across pricing channels. Core goods prices have kept year-over-year inflation elevated, even as shelter inflation moderates. This divergence complicates near-term readings and highlights why disinflation is unlikely to be smooth or linear.
Recent CPI data was affected by temporary distortions due to the government shutdown last year, adding complexity to the inflation narrative. As these effects subside, inflation data should become clearer. While these timing effects do not change the underlying trend, they influence how progress is measured and interpreted in the short term.
Tariff pass-through has been more moderate than expected. Unless there is a significant change to tariffs after the Supreme Court’s IEEPA decision, tariff effects should continue to fade into next year, along with further moderation in services inflation.
As labor markets approach balance, wage pressures are unlikely to drive further inflation, and money supply trends do not suggest renewed price acceleration either. This sets a conditional framework for 2026. If inflation continues to ease as shelter and services moderate and tariff effects dissipate, the Federal Reserve will have more flexibility to normalize policy without increasing inflation risk. This flexibility could support growth, even as labor-market risks change.
From here, the inflation outlook becomes increasingly a question of sequencing rather than direction. Goods prices, shelter, and policy effects are unwinding on different timelines, making labor-market dynamics the binding constraint on further progress. The pace at which labor conditions settle will determine whether disinflation accelerates, stalls, or continues at its current moderate pace, a dynamic which will ultimately determine how much flexibility policymakers have to normalize rates. This is the critical intersection where inflation and labor markets collide.
Labor Markets: Rebalancing Under New Constraints
The labor market remains central, but its signals have shifted.
An average of over two million net immigrants entered the workforce each year since 2021. As a result, the breakeven pace of job growth required to maintain balance was structurally elevated in the years following the COVID pandemic. Consistent with the administration’s’ goals, net immigration has likely slowed substantially under strict border enforcement, implying fewer job gains are required to sustain equilibrium. Slower headline job growth, therefore, reflects a labor-supply adjustment, not a collapse in demand.
This shift coincided with softer hiring and a higher unemployment rate last year, allowing the Federal Reserve to continue policy normalization. Headline labor data has also been further distorted by temporary, policy-driven disruptions, including reductions and furloughs in government employment, which affect reported payrolls without reflecting underlying private-sector demand. The unemployment rate has steadied, and labor supply and demand appear to have stabilized at a lower equilibrium. In this environment, the unemployment rate is a more relevant indicator of labor market health than headline payroll growth.
These labor dynamics must also be viewed in the context of policy sequencing. The administration effectively “kitchen-sinked” growth in 2025, pushing through disruptive policy actions early, including tariff realignments, strict immigration controls, and targeted reductions in government employment. While important to the broader agenda, these actions carried near-term negative implications for growth and hiring. That clearing event is now largely behind us. As policy visibility improves and uncertainty fades, labor conditions are better positioned to recover, particularly as growth broadens beyond the AI corridor and into the broader economy.
However, AI-driven productivity gains further complicated labor signals. Higher unemployment and stronger growth can now coexist, as automation enables firms to increase output without adding headcount. Traditional labor metrics should therefore be interpreted structurally rather than cyclically.
Households: Cost Compression as Policy Transmission
In 2026, household conditions mirror the broader macroeconomic tension. While labor market indicators have softened, consumer spending capacity remains strong. Layoffs are low, and consumers broadly remain employed. Moderating nominal wage growth, combined with declining inflation, has sustained positive real wages and supported consumption without requiring increased hiring.
Financial conditions remain favorable and support spending across all income groups, as equity market participation has widened. The resulting wealth effect continues to drive aggregate consumption. OBBBA-related tax refunds are expected to be significantly larger than last year, providing an early-year boost to household cash flow.
The U.S. hosting the World Cup will provide a modest boost to local economies over the summer. While the impact is small relative to overall GDP, it remains a positive regional tailwind for economic activity.
After suffering losses in off-cycle elections, the administration has prioritized affordability measures and lowering major household expenses in an effort to gain favorability with voter ahead of crucial midterm elections later this year. Measures such as the $200 billion in mortgage purchases have reduced borrowing costs, while proposed credit card interest caps and the Great American Healthcare Plan address interest and healthcare expenses. Although implementation may vary, the policy direction is clear: reduce out-of-pocket costs for households and improve cash-flow flexibility for consumers over the next few months.
This approach to policy transmission stabilizes consumption without causing overheating. Household spending does not need to accelerate significantly to support growth. With stable employment, supportive real incomes, and compressed costs, households remain a durable foundation for economic activity in 2026.
Growth: Capital Deployment Takes the Lead
With consumption stable, capital deployment may drive incremental growth in 2026 and directly affect rates. Corporate investment is now central to this transition.
Robust AI-related capital expenditures continue to drive the cycle, supporting investment in data infrastructure, software, and processing capacity. Although reported contributions have varied by quarter, underlying deployment continues to accelerate. The key point is durability: capital is being committed with the expectation of long-term productivity gains, even if returns are uncertain over the near term.
Beyond AI, the next phase of investment is emerging. Non-AI capital expenditures lagged in 2025 due to trade policy uncertainty and reshoring challenges, which limited spending on manufacturing, power, and equipment. This environment is improving. The administration’s reshoring agenda, foreign investment pledges from trade agreements, and incentives in the OBBBA, especially 100% expensing for manufacturing and equipment, have clarified tax benefits. As trade war uncertainty recedes, deferred investment is likely to expand.
Corporate balance sheets are well positioned for this transition. Profit margins are expanding, earnings growth has exceeded expectations, and leverage among the AI hyperscalers remain low even after significant capital investment. Most non-AI capital expenditures were postponed, not canceled, in 2025, leaving significant and readily deployable dry powder available as confidence and clarity return.
As capital deployment accelerates, corporate issuance naturally increases, adding another layer to the supply backdrop that markets will need to absorb. The rate implications crystallize through financing, as this investment cycle relies on a mix of internal cash flow and longer-dated debt issuance.
The takeaway is not simply stronger growth, but a shift in how that growth is delivered. A capital-led expansion brings financing, issuance, and sequencing to the forefront, setting the conditions under which rates, supply, and dispersion will ultimately be determined.
Geopolitical Volatility: Where Consensus Narrows, Risk Widens
The economic foundations set in place create a robust backdrop for activity in 2026. Growth is broadening, capital deployment is ramping, and policy sequencing has created visibility into the near-term. Yet this convergence of favorable conditions has produced a dangerous consensus: that geopolitical risk remains a second-order concern, priced lightly into markets, and unlikely to materially disrupt the macro trajectory. This assumption deserves scrutiny.
The administration’s geopolitical agenda is coherent and deliberately constructed around two core objectives: fortifying U.S. global dominance and systematically diversifying away from dependence on foreign adversaries.
Recent actions, including the strategic focus on Greenland, intervention in Venezuela, and systematic effort to reshore critical supply chains with tariff threats are not ad hoc or reactive. They are expressions of a unified doctrine. Looking beyond the surface of media headlines, the specificity of these targets reflects the depth of strategic analysis underpinning the doctrine. China’s dominance across the rare earth supply chain represents the kind of structural vulnerability that the administration views as unacceptable and an outsized threat to critical US industries. Viewed through this lens, the strategic underpinnings behind the intervention in Venezuela are apparent. By taking control of Venezuela’s oil production and reserves, the US gains leverage over China, a key importer of Venezuelan heavy crude. Beyond this offensive measure, the US strengthens its defensive positioning as well, gaining access to large deposits of key commodities, including oil, gold, iron, and potential undeveloped rare earth element reserves. Within this context, the move to annex Greenland is done with the intention of strengthening US defense in the Arctic, as well as gaining access to additional undeveloped commodity reserves.
These are not peripheral considerations; they are central to the administration’s framework for reshaping global economic and military positioning. The administration’s actions reflect strategic positioning, but the execution methods are increasingly escalatory. Greenland’s potential acquisition, Venezuelan regime pressure, Arctic militarization against NATO, and the broader effort to decouple supply chains from China represent an aggressive reshaping of geopolitical relationships. When the administration prioritizes strategic positioning over diplomatic consensus, the potential for miscalculation, unintended escalation, or rapid policy shifts rises substantially.
For markets, this dynamic creates a fundamental misalignment between positioning and risk. Consensus expects orderly curve steepening, stable growth, and measured policy normalization: a baseline scenario that implicitly assumes geopolitical tensions remain manageable and that U.S. strategic initiatives proceed without significant disruption or blowback. But this consensus has become increasingly concentrated, narrowing the perceived range of outcomes even as the actual realm of geopolitical possibilities has expanded.
Taiwan tensions, Arctic confrontation, Chinese countermeasures to supply chain diversification, energy market disruptions from Venezuela, or any of a dozen escalation scenarios could produce abrupt shifts in capital flows, confidence, and positioning. When such events materialize (and history suggests they will), markets will face a collision between the consensus baseline and reality. The timing and magnitude of positioning adjustments would likely be asymmetric: gradual pressure on yields from increasing supply and term premia in benign scenarios, but sharp declines in long-end yields and sudden flight-to-quality moves when geopolitical headlines shift unexpectedly.
The implications for portfolio construction are direct. In an environment where economic fundamentals support the growth narrative, but geopolitical execution risk is systematically underpriced, downside protection becomes not a hedge against recession, which the data does not warrant, but a hedge against the collision between consensus expectations and geopolitical reality. Heightened liquidity buffers, tactical long-duration positioning sized for volatility events, and strategic positioning toward assets that benefit from flight-to-quality flows all become appropriate risk-management tools. The challenge is not whether geopolitical risk will materialize, but when, and whether portfolios are structured to navigate the positioning adjustment when it does.
Collision Protection: From Framework to Practice
Amidst a tight consensus, the range of possible outcomes remains wide. The administration’s sequencing and pace of execution increasingly shapes how policy transmits through markets. The most important policy objectives have been put into motion. The critical question is what comes next, and how markets adjust as expectations reset.
In a year defined by collision risk, Collision Protection is not a metaphor, it is a necessity. When policy, markets, and fundamentals collide, progress is rarely linear and clarity rarely arrives all at once. The challenge is not the presence of uncertainty, but navigating it with discipline, perspective, and control.
That is where our focus remains. We are not positioned for a single outcome, but for a range of paths, grounded in fundamentals, attentive to sequencing, and prepared to adjust as conditions evolve. Participate and Protect continues to be our North Star, guiding how we engage opportunity, manage risk, and preserve flexibility as the policy landscape unfolds.
This environment rewards preparation over prediction, judgment over conviction, and process over posture. As the next items on the administration’s agenda come into view, we remain focused on what is priced, what is shifting, and where we are appropriately compensated for taking risk. The story of 2026 is still being written, and we are prepared to navigate it as it unfolds.
Let’s Talk.
The opinions and views expressed are as of the date published and are subject to change without notice. Information presented herein is for discussion and illustrative purposes only and should not be used or construed as financial, legal, or tax advice, and is not a recommendation or an offer or solicitation to buy, sell, or hold any security, investment strategy, or market sector. No forecasts can be guaranteed. Any investment or management recommendation in this document is not meant to be impartial investment advice or advice in a fiduciary capacity and is not tailored to the investment needs of any specific individual or category of individuals. Opinions and examples are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in the market or economic conditions. There is no guarantee that the information supplied is accurate, complete, or timely, nor are there any warranties concerning the results obtained from its use. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio.
The information included in this letter and provided link may contain statements related to future events or developments that may constitute forward-looking statements. These statements may be in the form of financial projections or may be identified by words such as “expectation,” “anticipate,” “intend,” “believe,” “could,” “estimate,” “will,” “should” or words of similar meaning. Such statements are based on the current expectations and certain assumptions of the author and are, therefore, subject to certain risks and uncertainties. A variety of factors may affect the operations, performance, business strategy and results of the issuer, and could cause the actual results, performance or achievements of the issuer to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements or anticipated on the basis of historical trends.
Past performance is no guarantee of future results. Investing in a bond market is subject to risks, including market, interest rate, issuer, credit, inflation, default, and liquidity risk. The bond market is volatile. The value of most bonds and bond strategies are impacted by changes in interest rates. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens. High yield or “junk” bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.
You should not construe this paper as investment, legal or tax advice. It does not take into account the investment objectives, financial situation and particular needs of any investor. Please consider the charges, risks, expenses, and investment objectives carefully before investing. Please see a prospectus, or, if available, a summary prospectus containing this and other information. Read it carefully before you invest or send money. Investing involves risk, including the possible loss of principal and fluctuation of value. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission from Smith Capital Investors. Smith Capital Investors, LLC is a registered investment adviser with the Securities and Exchange Commission (“SEC”). Registration does not imply a certain level of skill or training.
FOR INSTITUTIONAL INVESTOR USE ONLY SCI00800
