Macro outlook 2026: Beyond the wall of worry

BRIAN HESS: Hello, everyone. Thank you for joining us. And welcome to our fourth quarter macro webinar as we wrap up 2025 and look ahead to next year. I'm Brian Hess, portfolio manager on the Solutions team at Natixis. And joining me today, as usual, are Jack Janasiewicz and Garrett Melson. Jack is multi-asset portfolio manager and lead portfolio strategist at Natixis. Garrett is a portfolio strategist, and also a member of the Natixis Investment Committee. Now, on to the topics-- OK, Jack, let's get started with you and right into the economic outlook for 2026. Recently on one of our internal calls, I've-- I heard you describe the outlook for the US economy next year as ho-hum. What do you mean by that? It doesn't sound very good. Let's get into it, though. 

JACK JANASIEWICZ: Yeah, and I think that the ho-hum comment can be misconstrued a little bit. And I'll get to a little bit of the details on the back of that. But I think what got us into that first conversation to begin with was just looking at a lot of the-- a lot of our competitors, a lot of the Wall Street 2026 outlooks-- and certainly feels like there's a consensus as to what's expected for 2026. And that's a potential little bit of a bump in the-- in-- between the first and second quarter of the year, and then things settle back down. 

We believe some of this to be true. But some of it maybe we're not quite as optimistic on. And there's a few things I think that are worth talking through here. And that's what I wanted to walk through for this first segment of our conversation here. 

When we start to think about what's going on with the pillars of growth within the United States, we usually focus in about-- on four different things. And the first one is going to be, what are we seeing from a spending perspective when you talk about state and local governments? And what we get here is-- the Brookings Institute does a pretty good job of being able to project out over the coming quarters what state and local government spending will do. And you can see here that's what we're seeing in the blue line. And that purple line is the actual spending. So it does a pretty good job of tracking what actually comes to fruition. But the key here is that you have a pretty substantial drop-off. Over the last couple of quarters, we've seen roughly about a half a percent of gross domestic product (GDP), a contribution to GDP, coming from state and local spending. And that's probably going to slip a little bit and not really contribute anything over the next couple of quarters. The second one is basically looking at the residential housing market. And the residential housing market's really been in-- I guess you could call it almost a recession for quite some time. And part of that is, obviously, from higher mortgage rates. And another part of that is just from the affordability side, with the cost of housing being elevated. And so when we start to think about these things that go into that residential investment side of the equation-- also, just completions in residential housing starts really haven't been doing much, either. And so what you're looking at from the blue line here-- you're simply looking at the difference between housing starts versus completions. And obviously, you need to have a start before you get a completion. 

And so this does a pretty good job of, I think, indicating where we are within that cycle. And you can see that relationship has really dropped south here. And so as a result, we don't expect to see much coming from the residential fixed income-- residential fixed investment portion of the equation here. So two of those inputs-- really not helping very much. But having said that, where do we actually see some potential upside here? Well, that Capital Expenditure (CapEx) trade on the-- from the AI side of the equation, or even more broadly speaking, the tech side of the equation still remains pretty robust. But the issue that we have here is that when we start to look outside of the tech space, not much else is really going on. So just here, looking at industrial production and, really, the key components of that CapEx build-out with regard to the tech space-- so you're looking at things like computer equipment, communications equipments, and semiconductors. You can see all of those are basically moving up to the right here-- so again, positive contributions. You're seeing industrial production side of the equation from those individual items moving higher. But that blue line-- that's, basically, all of the other components within the industrial production complex ex that high-tech industry. It's really been moving sideways-- so a lot of what we're seeing from a growth perspective seemingly, at least, being supported by that tech component within the broader markets here. And then the last one to focus on-- we're hearing a lot about the potential for that CapEx being reinvigorated, especially as that One Big Beautiful Bill (OBBB) starts to kick in. So we've heard quite a few things surrounding the potential impact as bonus depreciation for new equipment starts to kick in, research and development (R&D) expensing, the increased cap for expensing limits, all of that starts to kick in. And we're certainly hearing a lot of optimistic takes in terms of the CapEx spend for next year with regard to the broader market. But it's one thing to talk about. It's another to execute that. And when we look at the surveys on sentiment regarding CapEx spend, we see a much more muted backdrop. And so what you're looking at here in the purple line-- that's just a survey that came from the US Business Roundtable, the CEO survey, talking-- or asking about what their plans for CapEx spend is-- you can see somewhat muted. And if you then expand that out to CapEx plans, and this is our composite, this is basically a summation of the Fed regional banks. They end up sending out as part of their survey, what are your CapEx plans for the next six months? So those regional surveys we roll up into this index here. And that's what you're looking at in the blue line-- and still fairly subdued as well. And I tried to put in the average over this entire period. 

So you can see on the chart here the purple dotted line represents the average. The actual the blue dotted line-- it actually sits right behind that-- so basically, the same number. But the point here is you're not seeing a re-acceleration in the-- in sentiment regarding CapEx spend. 

And at this point, with the potential ramifications from that OBBB, it's certainly well known the benefits that could be coming from it. So you'd expect some of these sentiments-- if they were really going to be followed through upon and acted on, you start to see that manifest in the expectations. And we're just not seeing that. 

So we're a little bit more hesitant in terms of some of the pass-through from that-- so maybe a little bit more muted with respect to that CapEx spend that we keep hearing about from the broader economy. Another thing that maybe we also could actually get from a supportive backdrop-- the political uncertainty, the economic uncertainty-- that could start to drop as we move into the latter half of this year. And this is just looking at the Baker, Bloom, and Davis US Economic Policy Uncertainty Index. All this is simply doing-- they go out, they search for keywords in a lot of news articles from different various media outlets, and they fold that into an index level. And so you can see it's been fairly elevated more recently. But the potential for that to continue to come back down, because I think a lot of what the Trump administration has wanted to do they've already put in motion-- and so maybe we get a little bit more certainty going forward, especially on the tariff front, for example. And that starts to come down. So as uncertainty starts to come down, maybe that implied volatility, things like the VIX or the MOVE Index-- that starts to come down. And as implied volatility starts to drop, people tend to be a little bit more optimistic about what's going on for the future-- so another potential supportive backdrop there. And really, the last pillar-- it comes back to consumption. And consumption is almost-- equates to roughly 70% of the US economic story here. Again, the old adage, never bet against the US consumer, probably still holds. But what you're seeing here-- the contributions to GDP coming from these individual pillars. And you can see more recently that light blue shaded bar-- that's consumption, consumer spending. It's been fairly resilient and fairly robust in terms of the contribution to overall GDP. And so when we think about what could potentially be supporting growth going forward, it really comes down to those two pillars that we just talked about. The consumer, which has been fairly resilient-- we could see some softening there. I think we'll get into that in a little bit. Nonresidential fixed investment-- that's the purple line. That's probably that CapEx that we were just talking about, the broader side, from the AI spend, for example-- those are really the sole pillars that have been supporting the economy. But is it enough to see a significant boost in here? For our perspective, maybe that just simply keeps us, basically, closer to trend level. And this is just the GDP estimates that we're pulling from Bloomberg, looking out for 2026. And this blue line here is what we're seeing from estimates regarding the 2026 outlook for the US economy. You can see we had a dip right around Liberation Day. We started to recover subsequent to that. We're basically just getting back up to that 2% backdrop. So forecasts right now certainly seem like they're calling for a return back to trend growth for the US economy, not necessarily a boost that maybe we're seeing from the consensus outlook. But having said all that-- and while this may sound somewhat muted here, this actually might be the perfect backdrop for equities going forward. And why do I say that? Because you're basically getting trend growth. I think if you got anything more robust than trend growth, the risk is that you might actually see the market getting a little more concerned about the Fed maybe no longer having to move into an easing bias here. So with this more muted backdrop, I think it keeps the Fed in play as we continue to tug-- chug along at that 2% narrative. That's actually a pretty good sweet spot for corporate earnings because historically speaking, we've seen GDP at something close to 2%, S&P 500 earnings have averaged right around 10%-- so not too bad from a perspective of the earnings growth backdrop for the market here-- so maybe not quite as optimistic as what we're seeing for some of the outlooks from the Street. But certainly, 2%-- that's probably a good enough backdrop to see some pretty decent returns for equity markets next year. 

BRIAN HESS: So ho-hum-- not necessarily bad, just maybe more like average? 

JACK JANASIEWICZ: Yep. 

BRIAN HESS: All right. Thanks, Jack. And you mentioned the OBBB a few times during that segment. So I'd like to drill into that a little bit more with Garrett. Garrett, Jack highlighted the potential for CapEx being pulled forward thanks to OBBB, or the incentives that are part of it, for CapEx. There's also a tax cut component. And so that might go a ways towards helping consumption. 

I'm curious to get your thoughts on-- Jack seemed to have downplayed the stimulative effects of the bill overall. I'm curious your perspective in terms of whether it be on CapEx or whether it be on the consumer side, if it could make a difference next year and maybe lift us a little bit above that ho-hum outlook. 

GARRETT MELSON: Yeah, absolutely. I think, to Jack's point, in terms of a lot of the outlooks that we've heard so far on the Street, it seems like this narrative is starting to gain momentum in terms of a potential re-acceleration, or maybe this reflationary type environment as we look into the early part of next year. And I think that really is underpinned by this idea that you have that fading policy uncertainty, as Jack mentioned. 

You have a shift from the administration towards more market-friendly, economy-friendly policy ahead of the midterms, maybe a deregulatory impulse, lagged effects of rate cuts. But I think the biggest driver of that narrative is just simply this idea that you're getting a positive fiscal impulse from those tax cuts, both at the corporate and the household level. 

And I think there is some scope for that to be supportive. But as Jack mentioned, you're already with an-- left with-- or starting with an economy that's maybe running at or slightly below trend, which isn't that bad. Maybe it gives you a little bit of a lift. But I think it's probably smaller than the consensus currently expects, and probably fairly short-lived. And so I think we're actually back to where we started last year, which is to say growth is holding up. But the consensus might be a little bit overly sanguine on the growth outlook. 

So a couple of things to just walk through here in terms of what the scope and the magnitude might be here, and the first one just starting with what's going to garner a lot of attention, which is this huge expected spike in tax refunds-- so what you're looking at here is just estimates going out for next year versus the trailing history of the average income tax refund issued by the IRS. And what you'll see here is, obviously, a massive surge for 2026 is, I think, north of 22% year-over-year. And the reason for that is the fact that we have these retroactive tax cuts for tax year 2025. But we didn't have any withholding changes to the schedule over the course of the year. So all of those tax savings, basically, come through in a lump sum at-- when consumers are filing their taxes-- so meaningful jump here. But as usual, when you start to break down the tax changes, they're regressive in nature. 

And so on the next slide, you'll just see that we've broken down the tax savings for 2026. And we've actually stacked that next to the changes, or the after-tax income growth, by income quintiles as compared to the Tax Cuts and Jobs Act back in 2018, in that first year when those tax cuts went active. And what you'll notice is the Tax Cuts and Jobs Act in light blue versus the OBBB in purple-- obviously, a little bit bigger. But you see as you move up that income threshold into the higher income cohorts, obviously, those after-tax gains get a lot bigger here. So a couple of things just to keep in mind in terms of the tax cuts-- that's not abnormal for tax cuts. And certainly in this environment where everybody's talking about the K-shaped economy, this just simply exacerbates that K even more. We've pushed back against that idea because it is really the normal state for the US economy. That income inequality/wealth inequality is maybe an unfortunate byproduct of what the economy has been over the last 40, 50 years. But it's kind of the norm, and this certainly exacerbates that. The other thing to keep in mind-- as I mentioned, the tax changes were retroactive. And that wasn't the case with the Tax Cuts and Jobs Act. So instead of a lump sum, you actually just had those withholding changes-- so those after-tax gains, basically, accruing over the course of the calendar year. So there's a couple of things to keep in mind in terms of the differences here. But the reason why I lay that back is that there's no denying that there is a material tax savings for consumers across incomes. The question is whether that translates to a material growth impulse, mainly through consumption. And that's less clear. And I think when you look back to the Tax Cuts and Jobs Act, you can see that that impulse was pretty limited here. And I think that's the idea behind this trickle-down economics. It doesn't really tend to boost growth for a couple of reasons. So if consumers are seeing an increase in disposable income, they have a couple options. They can spend that, they can save that, or they can pay down debt. And if you look back at what I've highlighted here in 2018, again, the caveats here being the difference in the scale and size of the tax cuts-- a little bit bigger-- the method being retroactive versus-- in a lump sum versus spread out over the calendar year-- but the point still holds here. 

The light blue line is just simply a measure of household leverage-- so revolving credit outstanding as scaled to disposable income. And what you actually saw is that credit just simply didn't grow at the same pace that you saw disposable income grow as a result of those tax increases. So what does that mean? Basically, at the margin, consumers were somewhat saving or paying down debt because credit wasn't growing at the same pace. And you can see that if we scale credit to consumption-- basically, moving sideways here as well. 

So you didn't really see this huge spending surge. And if you just look at explicitly spending data, it basically was just in line with the 2014 to '19 average if we exclude the 2018 calendar year. There wasn't any sort of anomalous increase in consumption in 2018. 

So it's hard to say that this is really going to translate into a material increase in consumption. I think the biggest question is a function of the fact that you have a huge amount of these tax savings going to higher income consumers. They tend to have a higher propensity to save. And so you're really wondering what the lower incomes are going to do. 

First off, lower incomes drive a smaller portion of aggregate consumption here. So you're really talking about a more marginal impact on the overall growth picture. But the bigger story is what are they going to be doing is probably a function of their confidence. 

And if you look at the next slide here, if you break out consumer confidence-- and yes, we'll be the first to criticize the fact that surveys like the University of Michigan Consumer Sentiment survey-- very partisan, a bearish tilt as a result. But not all surveys are created equal. And this is a look at the New York Fed survey of consumer expectation. 

This tends to be a little bit more robust. And if you actually break down, basically, job-finding expectations by income, take a look at that light blue line here. That's for your lowest income cohort, making under $50,000 per year, basically at the lowest levels on record here in terms of their confidence in their ability to find a new job if they were to lose it now. So if you think about what's going to really influence whether that lump-sum tax refund gets spent, sure, probably some of it's going to get spent, especially given the fact that those lower income consumers have a higher propensity to consume. And the US consumer is going to do what it does best, which is spend income. 

But if you really think about what durably drives consumption decisions, it's really going to be driven more so by income expectations and confidence. And I think what you can clearly see is that confidence is somewhat shaky here, especially at the lower incomes. 

So bottom line here is I think the impulse is probably going to be a little bit more muted than expected here. And so if you think about, going back to some of Jack's comments on consumption story being pretty resilient, but maybe a little bit of downside-- again, I think we're back to where we were at the end of last year, which is to say if you look at it on the next slide, consumption spending versus disposable income in real terms, you have this gap that's opened up. And you can see that happens over time. So real disposable income, excluding government transfers, in the light blue line mapped over real consumption here-- and you can see they oscillate around each other. So consumers will outspend for a little bit relative to income growth. And then they'll-- you'll see a convergence, and maybe spending will undershoot income growth for a little bit. And they'll zigzag around each other. 

Where have we been over the last couple of years? Well, that resilience in consumer spending has really been a function of consumers dissaving, that saving rate getting drawn down, basically spending a little bit more. And as a result, what you're seeing now is this convergence where income growth is somewhat modest, given the fact that we've seen a slowing in employment growth. That's translating to slack building in the labor market and downside pressure on wage growth. And so what you're seeing is probably a case for that consumption story to start to catch down towards incomes. Now, it might be a little bit of a convergence. Tax cuts are going to push that light blue line a little bit up here. But to me, it suggests that when you put it all together, is there reason to be maybe a little bit more optimistic for spending impulse? Sure. But I think, relative to expectations for this huge spending impulse in the first half of the year, I would probably lean against that. I think it's going to be a little bit more muted. Now, the last thing to keep in mind, just to add a little bit more color on what Jack touched on on the corporate side of things, is tax policy is just one part of the equation when it comes to corporate investment planning. So while tax policy changes are helpful, what tends to drive CapEx and corporate investment is going to be simply the growth outlook. Growth drives and leads investment. And so when you think about this, again, hearkening back to the Tax Cuts and Jobs Act, the policies being rolled out under the OBBB are basically just reinstating what was in effect in 2018 from the Tax Cuts and Jobs Act-- so 100% bonus depreciation for CapEx, and then that accelerated full expensing for R&D. We're not fully back to 0% on the depreciation. So it's not necessarily a 0% to 100% gap. We're about 40%. That jumps to 100%-- so a little bit more encouraging. But take a look at what happened in 2018 and '19. CapEx intentions, just what Jack had laid out in the earlier slides, in light blue versus a measure of actual CapEx investments-- so core durable goods shipments in purple-- well, they basically were at the highs coming into 2018. And despite the tax policy changes, what happened is intentions and actual CapEx spending went straight down over the next two years. 

And that was basically a function of the fact that ROIs just weren't all that great because the growth outlook was souring here. So while you can lead these corporates to the water, per se, in terms of making the environment a little bit more conducive for CapEx spending, if they just don't see the ROI there because the growth prospects aren't all that great outside of the AI complex, it doesn't mean you're going to get this big surge in CapEx. And I think the last thing to keep in mind is we've known these policies have been in the pipeline, basically, since the election results. They've been signed into law for almost half a year at this point. Corporates are already planning for that outlook. So it's not like they're waiting for the calendar year to flip to '26, and then all of a sudden we're going to let loose all this CapEx spend. That was retroactive. And the fact that we're not already seeing that pickup in CapEx intentions, I think, suggests that you're probably not going to see a huge amount of lift, at least in the near term, out of CapEx here. So bottom line-- does it help at the margin? Probably. Is it going to be as game-changing as some of these narratives suggest? Probably not. 

BRIAN HESS: Well, you've thrown a lot of cold water on the idea that we're going to have an upside growth surprise thanks to the OBBB. 

GARRETT MELSON: Right. It's a ho-hum economy, as Jack said. 

BRIAN HESS: I guess it still is. Well, that was supposed to be the upside surprise. So now I feel like we need to swing and talk about the downside risks. So let's go there. You're not overly excited about OBBB-- got that. How about the other two risks that were-- or the two big risks, I guess, we're talking about here internally? 

The first one is a potential slowdown in AI investment, which I'm going to ask Jack about that later. So let's just put that on-- to the side for now. The second thing, which we've been highlighting for a while, but it's still very much in play, has been deterioration in the labor market. If that continues to slow or if that worsens and we swing to net job losses, that's definitely going to put pressure on consumption. 

So still, Garrett, you-- how concerned are you about the US labor market and then, again, how that might feed into the Fed's assessment of its balance of risk? We have inflation still above target for the Fed. But we do have a clearly decelerating labor market. And that puts them in a little bit of a tough spot. We're going to hear from them in about 30 minutes or so, which will be interesting. What's your thinking about how they'll balance those two competing priorities as they think about if they can continue cutting through 2026? 

GARRETT MELSON: I might actually flip this around.What Jack mentioned-- ho-hum is not necessarily a bad thing-- not trying to put ice on the growth outlook here. But I think it's enough to keep growth maybe just below or around trend. And on the flip side, as Jack mentioned, that probably makes it a little bit easier for the doves to take back control of the Fed here. And the Hawks have certainly stolen the spotlight recently. But I think their case is-- grown shaky over the last couple of months here. And the first one is just simply, take a look at the trends within the labor market. This hasn't changed. So we're still dealing with this data vacuum. We're not going to get a household survey, which is where we get the unemployment rate for October. We're not going to get a full Consumer Price Index (CPI) print for October, either. We'll get some data released, I think, next week. But we're still in this data vacuum. But as we've stressed, it's not just-- the macro outlook is not going to boil down to a single data point here. It's always a mosaic. Look at the mosaic. And the trends are still pretty clear here. So if you just take a look at ADP, as well as the Revelio, which is another private sector jobs print that we've started to rely upon, look at how those tend to trend relative to non-farm payrolls in purple here. And they're all, basically, moving the same direction. There might be some zigs and zags here and there along the way. But if you smooth through some of the monthly noise, look at a three-month average-- pretty clear that the pace of jobs growth is slowing down in here. And you can broaden this out. Look at the Fed's Beige Book. That continues to point to cooling, Purchasing Managers’ Index (PMI), employment survey subindices still in contraction across manufacturing and services. The Conference Board's labor differential continues to drift lower, suggesting upside to the unemployment rate. The JOLTS survey-- we just got that yesterday-- continues to basically suggest that we're in this low-hire, low-fire environment. So the trends are still pretty intact here. That suggests that the risks are still pretty clearly skewed to the downside for the labor market. And I think one little nuance or one little point to harp on here that's probably going to start entering the narrative again is this idea of the Sahm rule. So that's this-- the obsession that we had last year where we got Sahm rule trigger. The market basically priced in a growth scare. I think we should be prepared to see this start to flare its head again as we move into next year, reason being for all the focus on the number of jobs being added-- certainly, there are some effects and distortions from labor supply dynamics-- we're still in the camp that labor demand is the bigger issue here. And so that means you should probably focus on some of the ratios coming from the household survey, like the unemployment rate, to give you a better sense of slack building in the labor market. And the Sahm rule, remember, is just basically a measure of momentum for unemployment. The risk with unemployment is nonlinear-- it's that when it starts to move, it tends to move pretty quickly. And it doesn't just go sideways. Well, the last couple of years has been anomalous in that regard. But that's because it was very much driven by a positive labor supply dynamic, people coming back into the labor force. 

We're dealing with the exact opposite right now because of immigration policy. And so if you actually break down what's driving the unemployment rate this year, it's moving up pretty substantially. And it's being more of a function of low hiring rates-- so more and more people being stuck in the ranks of unemployed. And you have seen a little bit of an uptick in actual layoffs and separations here. So it's a less benign increase in the unemployment rate. And I think if we continue to rise at the pace we've risen since January, you're probably going to be triggering that threshold, which is about 0.5 over the last year's lows. That has always been, basically, either you're in a recession or you're about to go into one. And so I think this is going to enter the narrative. Maybe that opens the door to a little bit of a growth scare or startle again, but something that we're probably going to have to start grappling with again as we roll into 2026. The good news, though, is that on the other side of the mandate, things are, arguably, getting better. And so, again, the doves have enough data on the labor side to point to the fact that they should be erring on the side of caution. 

And on the flip side, the game's getting a little bit easier in terms of inflation prints have been undershooting expectations. They've been printing in line with expected or below every month since January. And that suggests that underlying inflation pressures are probably lower than people expect. And the pass-through, as we've clearly seen, has been lower and smaller than expected from tariffs. And yeah, sure, there's a little bit of concern that there's a little bit more pass-through to go. We all know about the front-loading of inventories. Maybe there's a little bit more pass-through to come as inventories get depleted. But if you look at effective tariff rates, we're already sitting north of 10%. The statutory rate is somewhere around 15%. And that keeps coming down because the Trump administration keeps kind of carving out and making exemptions to alleviate that strain on the consumer here. And so I think there's a good case to be had that a lot of that pass-through has already played out here. It doesn't take a whole lot, if you look at some of these projections here, assuming some of these different monthly rates-- well, you undershoot the Fed's year-end target for this year, which they might have to revise down in just a half-hour's worth of time from here. But it doesn't take a lot of somewhat softer prints to make a lot of progress pretty quickly next year. And so there's actually a risk that maybe they have to revise down their forecast for inflation next year at the same time they're revising up their unemployment rate forecast. That means the doves very firmly have control. And that makes it an easier path to continue easing. The last thing to just keep in mind-- the inflation backdrop, as we've talked a lot about shelter disinflation. That's still very much intact, and I think will accelerate next year. But there's also some reason to be optimistic on, basically, items outside of shelter-- namely, supercore services. If you think about food service inflation as, basically, a microcosm of the economy, you're going to have goods import inputs. You're going to have commodity inputs through food prices. And then very sensitive to labor costs, it's this amalgamation of all these different inflationary impulses in the economy. Well, if you take a look at food services inflation, it had ticked higher. But you're starting to see it stabilize and maybe start to roll back over. That tends to lead supercore services, excluding housing, back down. And it tends to lead core inflation, as well-- so maybe some reason to be a little bit more optimistic on the overall inflation backdrop, not just on shelter carrying those prints lower here-- so again, a little bit of reason to be more encouraging. So if you think about central banking and the Fed's decisions here as basically risk management, I think you can boil it down to the next slide being that-- take a look at their dual mandate. The light blue line is the unemployment rate. The dotted line is their year-end target for 2026. We're already there, with risks to the upside in a nonlinear fashion. Now, look at the other side of the mandate. The purple line is their core inflation relative to target. Well, we're not all that far away from their expectations by year-end. And there's a case to be had that conditions are getting better on the inflation outlook-- well, pretty clear which side of the mandate they should be responding to at this point when inflation tends to move in linear fashion and it tends to be a lagging indicator here. So from our perspective, ho-hum economy is not a bad thing. And when you take a look at both sides of the mandate, it certainly suggests that the easing bias is intact. And if you look at market pricing on this last slide, the terminal rate certainly seems to be compressing in this trading range, zeroing in around 3%. 

So if you assume that the Fed follows through a market pricing with a cut today, you're still pricing in two more to get down to about 3% for neutral by the end of next year. And that can help to alleviate some of those strains on the labor side of the mandate-- again, a decent growth backdrop and a Fed that still has an easing bias. I think that's still a pretty constructive risk backdrop. 

BRIAN HESS: So it sounds like if the Fed had asked you to submit a dot plot for this week's meeting, your dot would be one of the more dovish on the page, right? 

GARRETT MELSON: Yeah, I'd say so. And I'd say there's risks that maybe even the market's underappreciating that you could get some more cuts next year than what's currently priced. 

BRIAN HESS: And I feel bad because when we lay out these-- when you think about these webinars, we have topics we want to cover. And Jack likes to talk about some things, and Garrett likes to talk about some things. And usually, we try to mix it up. But for some reason, this quarter, we sequenced Garrett three in a row. So I'm basically just stalling now so Garrett can take a breath, have a sip of water if he needs it, before we move on to the next topic, which is very closely related to the one we just covered. 

JACK JANASIEWICZ: I need to submit the dot plot by 3 o'clock. 

BRIAN HESS: And then he has to go submit that. Exactly. 

JACK JANASIEWICZ: You've got to get out of here. 

BRIAN HESS: So let's stay with the US interest rate market, basically, but extend it further out the curve. You just highlighted the labor market. You highlighted inflation. We know where you stand with respect to Fed policy and your theoretical dot plot. What does that mean for the rest of the Treasury curve? What does that mean for the Treasury market overall? 

It's been a good year for the US Agg (Bloomberg US Aggregate Bond Index) this year. But we're pretty close to 4% for the 10-year Treasury, which has been a big area of yield support. And the Fed-- we're going to find out shortly. But there's a chance that they're going to go on hold after hiking today. So let's think about 2026 and what we might expect to return from the fixed income market. 

GARRETT MELSON: Well, I appreciate the little breather there. And I'll keep this section a little bit shorter because I think it's-- you look back at this year. It's been a very strong year for fixed income. I think next year is setting up to be a pretty attractive and pretty good environment for carry again here. So a couple of things just to keep in mind, the first one being-- we talked about the Fed's pricing. I think it's important to get a sense of the market's pricing not just in the average sense, which is what I showed in the last slide, but again, if you think about central banking as a distribution of risk or managing that distribution, think about market pricing for cuts as a reflection of all those different outcomes and that distribution again. So you have this bell curve. Looking at the curve right now, the market's pricing in three cuts to get to neutral, or the terminal rate. But if you look at where the bulk of that pricing is, it's only pricing in about one to two cuts by September of next year. So I don't have the full curve out to the end of 2026. But you can see the tails do a lot of heavy lifting. If you just look at the moves, basically, since the last week of November just prior to Thanksgiving, you can see we're compressing the left tails. So all those downside scenarios in the left tail we're compressing and pricing out. And we're actually fattening the right side of the tail and zeroing in on maybe a little bit more of a hawkish central tendency to this distribution here. So I think there's a case to be made that the markets certainly are already pricing in this potential hawkish pause that we'll get from the Fed today. And if anything-- might create scope for the market to shift more dovishly as you move into-- throughout 2026 here. Getting back to this idea of the-- this reflationary re-acceleration narrative, I think some are pinning the move in the backup in yields that we've seen, especially at the long end, over the last couple of years on that idea. But you don't really see it in the data, at least from a reflationary perspective. If you look at inflation expectations, they've been basically anchored or, if anything, moving lower. So this is just simply your one-year inflation expectations in the light blue versus your one-year one-year forward inflation expectations-- so basically, that one-year window starting one year from today. Well, that's basically been very stable at 2 and 1/2%. But what have you seen for one-year inflation expectations-- been a straight line lower-- even the last couple of weeks been stable here-- so very much consistent at 2 and 1/2% or so with, basically, the Fed's 2% target when you consider that CPI versus PCE gap-- so not seeing much in terms of the market pricing in stronger inflation. I think what you could argue is that even here domestically, and even on a global basis, the backup in long ends that you've seen globally is probably more a function of repricing their growth outlook. And that's what you see on the next slide here-- is if you think about real and nominal yields being a reflection of growth expectations, what you're looking at here is basically taking those consensus growth expectations Jack showed earlier and just making-- creating a rolling two-year forward window for US GDP growth. 

So that's what you're seeing in the light blue line-- is that rolling change in expectations for US GDP growth in real terms. And the purple line is just the change or the level of the 10-year real yield here for the US. And you can see they tend to track pretty closely. 

So as growth expectations fall, real yields fall, and vice versa. You have this gap open up where if growth expectations picked up and real yields didn't, I think what you're actually starting to see is basically a convergence of that playing out. And if that's the case and now you look out into next year and maybe you have a case for the consensus may be overpricing growth a little bit to an extent, that creates a little bit of scope for maybe rates staying a little bit more range-bound to maybe even having a little bit of scope for a rally if you're pricing in more cuts as well as maybe a somewhat softer growth backdrop relative to the consensus estimate. The other one to keep in mind that I think is supportive for investors is the fact that volatility is compressing. And I think Jack mentioned this. You can clearly see this in fixed income volatility. This slide is just simply looking at the MOVE Index. So basically, think of that as the VIX for the bond market-- so implied volatility across the Treasury curve. And that is the light blue line that's been compressing very steadily and moving almost in lockstep with US trade policy uncertainty. So as trade policy uncertainty has faded rapidly and has, basically, fully normalized, you've seen rate volatility compressing. That's really good for carry for fixed income because that helps to mute volatility in the curve. And so bottom line-- I think you're left with an economy that-- growth is holding up fine, running at or modestly below trend. The inflation outlook is, arguably, getting better. Labor markets are cooling. But they're not necessarily cracking. And most importantly, that easing bias remains intact. So if you think about opportunities in fixed income, I think that sets you up for a pretty good backdrop of pretty solid carry if you think about both nominal and real yields in pretty healthy territory here. And this last chart is just simply the market's current expectations, looking at the current year yield curve in light blue versus the forward one-year curve. Now, I'm not saying that the market's pricing one year out is spot-on, no pun intended here. But what it does suggest is basically that the market is reflecting that you'll see some rally at the front end. And basically, that's just realizing the market's expectations for rate cuts that are priced in right now. And you really don't see a whole lot of steepening at the long end. So you have this lower volatility, more compressed, narrow trading range for the curve. I think that's a pretty good backdrop for fixed income investors to, basically, have another strong year of carry and some pretty solid returns in here. 

BRIAN HESS: I guess the other benefit to keep in mind for treasuries is that if, for some reason-- if our view is wrong or some of these risks manifest more severely, we start losing jobs, Treasuries will provide a hedge, most likely, in a downside scenario for the economy. So to the extent that they probably would have a negative correlation against risk assets in a surprise downside outcome, that has some value. 

Meanwhile, if rates do rise a little farther than we're thinking, with the 4% or so starting yield for the Agg, that can absorb some amount of rate rise before we start losing money-- so a case can be made from, I guess, an upside-downside standpoint for bonds a lot more easily than it could have been in the earlier part of the decade, when rates were closer to 0%. 

GARRETT MELSON: Exactly. 

BRIAN HESS: All right, Jack. You're back in. We're calling your number. And we're going to go to risks again. And I highlighted this earlier. The slowdown in AI spending is something that a lot of people are talking about, the potential-- not that it's happening, but the risk that it could. And so first, I'd like you to just elaborate a little bit about how serious of a risk you think that is, what you're looking at to track it. And then if you could speak more broadly about AI bubble concerns and where you stand on that question, I think that would be interesting for our viewers. I'm not necessarily expecting you to say, yes, we think it's a bubble, or, no, we don't. This is a very complicated topic. But I'd be curious to know how you're assessing the potential durability of the AI theme in markets, which has been a huge driver. You showed how strongly it's been driving growth, along with consumption. But it's also clearly been the dominant theme responsible for sector performance and industry group performance within the stock market. So let's talk about the AI bubble. 

JACK JANASIEWICZ: It's certainly a-- probably risk number one here. It's something that we pay a lot of attention to. Internally here, we continue to draw up all sorts of different dashboards to help monitor the evolution of the AI trade, whether it is from CapEx spend to just performance of the individual sectors within the tech space to the individual names. 

Obviously, when you look at the contribution to growth over the last couple of quarters, just averaging the first quarter and second quarter, it matched, basically, the contribution from consumption. You're talking, with consumption, almost $21 trillion, the size of the CapEx spend not nearly that big. But it just shows you the rate of change, how big that change has been in a short span, and how much of an impact it really has had on growth. 

So it certainly is a huge risk. The two that we continue to talk about for 2026-- it's going to be the labor market and it's going to be the AI CapEx story here. But a couple of things I think that are worth talking through with regard to the AI backdrop and how we're thinking about things-- and we've talked about this in the past with some of our other output and some of our other webinars here. It's simply that right now, you continue to see a lot of the hyperscalers continuing to fund CapEx via operating cash flow. And so you're not really going out and borrowing and leveraging yourself up. And this chart here just looks at the individual names within the hyperscalers. The purple bar just-- that's the amount of cash flow coming in. Now, this is-- I pulled these numbers from analyst expectations for 2026. So these are actual estimates across the hyperscalers for next year. So again, the purple line's showing the absolute number of cash flow coming from operations. The light blue-- it's just heading south. That's the CapEx spend. And across the hyperscalers, when you net the two out, purple bars are, obviously, going to be bigger than the light blue bars. So CapEx can continue to-- or is expected to be continued financed through cash flow from operations. 

What I've shown also in here, though-- and that's the little diamonds in there with regard to the line that cuts across-- we start to factor in returns to shareholders. So things like buybacks and dividend payments-- can those continue to persist without having to dip into potential borrowing going forward? And you can see on the far left there Meta, Microsoft, and Oracle start to run a little bit of a deficit. So from their perspective with regard to shareholder returns, maybe some of this does have to be financed as opposed to strictly coming from cash flow from operations. But I think that's a big difference because when we start to think about what happened during the dot-com era, a lot of that was not really financed through cash flows from operations. That was largely financed from borrowing. And obviously, when you have poor investments, when those things go south, you're basically destroying your balance sheet. And then you have to go through a period of balance sheet repair. But obviously, things have shifted a little bit. And there's a little bit of a concern that some of the more recent spend has been financed through bond issuance. You can see here I've just looked at the investment-grade bond issuance that we've seen so far this year. And we've had a pretty good uptick. Some of the sizes of these deals coming from the hyperscalers, particularly, have been pretty significant. And so I think that's raised some eyebrows. And that's spooked a few investors with regards to the potential of, all right, maybe we are starting to see that bubble form. And I think some of this is really idiosyncratic. I think one that you could really point to is Oracle because they've done quite a bit of financing through the debt capital markets relative to the other hyperscalers. And when you look here-- just showing you, basically, the leverage ratios here, long-term debt relative to capital. You can see on the far right Oracle stands out well above the S&P 500 average. And as you move from right to left, you can see the rest of the hyperscalers are largely in line with the broader tech space, which tends to operate at a little bit of a lower leverage multiple than the broader S&P 500, and then NVIDIA and Alphabet to the far left, even much lower than that-- but the point being, I think, in general, when we look at the leverage that is being taken on by the hyperscalers, in general, I think-- or again, Oracle is the outlier here. They're still pretty contained. And when you think about the ability to actually make payments on these borrowings-- let's just zero in on the interest coverage ratio. You're looking at EBITA (Earnings Before Interest, Taxes, and Amortization) to interest expense. And again, the one outlier continues to be Oracle-- move across, going left to right. So as those bars increase, the ability to make those interest payments is actually becoming stronger here. 

And so, again, the hyperscalers from that ability to meet those coupon payments-- better than the S&P, and strongest in terms of the overall tech sector. And I couldn't fit NVIDIA on this bar chart because NVIDIA's interest coverage ratio went through the roof. You would basically not be able to see the rest of the chart as a result if we included that. 

So maybe the way to think about this-- if I were an investment-grade manager and these guys are coming to issue and we've seen a little bit of spread widening off of the issue because of, I think, the supply, just the absolute size of this stuff, these are pretty good investments, it seems, from a relative value perspective. So certainly, when you look at them in regards to the overall high-grade market, these certainly look like the pretty solid credits in here. And alluding back to the idea of, are we in a bubble, again, when you think about dot-com era because that's really where a lot of the analogy comes from, those individual names back in the day were trading at multiples north of 70 times. If we look today across, basically, the Mag 7 (Magnificent 7 Stocks) or the hyperscalers here, you can basically see the bulk of these are trading at below 30 times. So again, I'm not sure if 30 times forward multiple with regard to P/E (Price to Earnings ratio) is something that I would be labeling as a bubble going forward here. So we've seen earnings have grown into the prices. And I don't think that's anything that's going out of the way. But the one thing that I will highlight-- the market is no longer treating the hyperscalers and the AI trade uniformly. We're seeing things starting to shift. And the winners and losers are actually starting to be drawn here by the market. And just looking here at the peer-wise correlation-- so the correlations of all the hyperscaler names relative to each other and averaged across-- you can see how they actually started to increase at the beginning of the year. So in general, the hyperscalers, the Mag 7's , trading in tandem-- that's dropped off pretty significantly more recently. And so the point here-- we are starting to see a more discerning investor backdrop. And you're starting to look at winners and losers here. And as a result, I think that's something to think about going forward. And maybe this does make the case for active management because obviously, from a passive management perspective, you're going to be buying all of this. And you're going to have winners and losers. And maybe the risk for next year is that some of the winners are offset by the losers in the aggregate space within the hyperscalers and within the Mag 7-- really look like they're not going anywhere. But you have some outsized winners and some outsized losers. 

And as a result, active management is able to take advantage of that-- so an interesting dynamic that we're looking at and thinking about with regard to portfolio structuring. And maybe it does make a little more sense to look at actively managing that sort of-- the large-cap equity space, simply because you are going to see winners and losers. And you're not going to be able to take advantage of that when you start to think about it from a passive and ETF investment perspective. 

BRIAN HESS: That's an interesting twist, Jack, and one that I haven't heard. I think that peer-wise correlation chart is quite a good one and not one that's been circulated widely, at least not that I've encountered too many times-- so great point you're making in the ability to pick stocks in an environment where there's better differentiation between winners and losers makes a lot of sense. And we have a lot of strategies that do that. 

So let's stay with the idea of risks, but shift from the equity market to the fixed income market. We had a few high-profile defaults earlier in the year. Those businesses were generally in more niche areas of the economy-- so maybe not the kind of thing you want to extrapolate to the broader credit environment. But there has been a lot of growth in private credit over the past 10, 15 years. And those bankruptcies earlier in the year were enough to create a concern that, hey, maybe that's just the tip of the iceberg. So maybe we can wrap up today by talking about the growth of the private credit market and the shadow banking system overall in recent years and then touch on what we're seeing with respect to delinquency rates in the US and if any red flags are being raised there. 

JACK JANASIEWICZ: And I think you hit on the salient points there, Brian-- a lot of concerns about what has gone on with regard to private credit. But I think those issues have been much more idiosyncratic-- so very specific to those individual names. And from a portfolio management perspective or risk management perspective, I think the bigger issue that we would pay attention to is, really, is this a systemic risk? That's what we're really, I think, trying to get to here because from a managing of a models perspective, a portfolio perspective. If we have these idiosyncratic risks-- yeah, but we're-- technically should be owning diversified portfolios. You get a couple of names that may have some difficulties. But in aggregate, when you have a well-balanced position there across many issues, that gets canceled out, so to speak. So I want to address, is this really a systemic issue that we should be talking about, and how that relates back to the banking system. And I think to summarize right off the bat, no. I think we would have already seen some of that manifest already. So again, this first chart here-- just showing the actual increase in the size of the private markets and BDCs. So again, the BDCs are going to be Business Development Companies. And again, those are vehicles that do some of the investing into the private markets here through direct lending. But the key here is that we're just simply seeing things really increasing at a pretty interesting and aggressive pace. The one other thing to pay attention to here, though, is I've split it out looking at private debt and the invested capital, and then the dry powder. We'll get back to that in a second. But that, I think, is a pretty unique thing to think about because that dry powder does give a little bit of cushion in here. 

So should things actually start to head south-- and typically, when you start to worry about things in private markets, it's the liquidity factor. You start to hear about redemptions piling up and the gates get thrown up. That's when a lot of the red flags start to hit. But some of these private debt companies simply have some dry powder there that actually can act as a buffer in terms of meeting some of those redemptions going forward. 

But taking a step back and getting back to the systemic risk issue, who does the bulk of lending to these private companies? And so in this case, we're going to lump private debt and BDCs under what we call this Non-Depository Financial Institutions-- so NDFIs. Who does the bulk of the lending to that here? And you can certainly see that lending has largely been driven more recently to the NDFIs. So you're just looking at all loans and leases here in the light blue, and the purple line ex NDFI lending. So again, you can see a little bit of a split more recently-- so certainly making the case here that a lot of the lending more recently is going to that segment of the marketplace. But again, who is doing the bulk of this lending? It's really coming from large banks here in the United States. And so again, just looking at the commercial bank loans to NDFIs, again, the Fed puts this out with regard to their monthly data. And you can see down on the bottom there small domestically chartered banks-- roughly about $175 billion worth of loans that are going to the small-- or to these NDFIs. The more important one, though, is that purple line. And you've seen a pretty significant uptick more recently there. So large domestic banks are the ones that are, basically, doing the bulk of lending. And as a percentage of what we're talking about with the book, again, from the perspective of large banks, again, that's roughly about 5% of their total assets that they're lending out here. But when we go back to talking about what these banks are doing, again, think about it from this perspective. Banks are lending to BDCs and to those private debt funds. They're not actually lending to the individual borrower, in most cases. So again, these banks are lending to what basically should be diversified baskets of investments. It's those individual companies that are then going out and lending directly to these companies. So from a bank's perspective, they're lending to a well-diversified portfolio at the aggregate level. So if something does happen, there's a fuse breaker in between that direct lender, the BDC and the private debt company, and the large banks. So seeing that really work its way back to the banking system, a lot has to go wrong for that to happen here. And again, this goes back to, again, what we were talking about earlier, commitments to BDCs relative to what's been utilized, private debt funds, the commitments relative to what's been utilized. And there's a pretty healthy gap in there. So from a BDC perspective, you've got almost $24 billion of dry powder, based on the most recent data we were able to procure, and from private debt funds, roughly about $15.5 billion-- so a decent little cushion built in there. But again, when you think about the leverage ratio-- and this is what got the banks into trouble during the financial crisis, when you were talking about leverage ratios in double digits. When you start to look at the leverage ratios for a lot of these BDCs and private debt funds, that leverage ratio still remains fairly benign. You've seen it tick up more recently for the BDCs. But in the absolute numbers, there-- are still pretty small. So to have this systemic-wide meltdown because of leverage in the system-- that's been fairly well contained. And as a result, I think if you started to see some issues and a lot of these sort of cockroaches that we had heard about, a lot of that was starting to manifest during the summer of this year. And so I think you would have started to see some of these banks reflect their concerns with regard to the potential bad loans that have-- may have been made to BDCs and to the private debt players here. And you're not seeing that. 

And a couple of examples here this-- is coming from the FDIC, the most recent numbers through the third quarter here. It's just, what are we looking at with regard to delinquent loans and leases? And sure, we had a little bit of a more recent uptick. And we would call-- maybe call that more of a normalization back to the pre-pandemic levels here. 

But again, based on the numbers that we've seen over the last couple of quarters, those delinquency ratios are actually coming back down. In that light blue line, those are the smaller banks that maybe have a little bit more of a risky bias towards their lending-- pretty significant drop here-- so again, normalizing and now starting to roll back over and head lower-- so not seeing a massive uptick in delinquency rates. If we look at charge-offs for loans and leases-- again, the same idea here. And you start to take these charges when you start to realize that you're not going to be repaid on some of these investments. Those are actually being either, A, stable or, B, rolling over for, again, some of those mid-tier banks. 

And then the last one to focus on-- again, you start to see, I think, some of these loan loss reserves picking up if banks were starting to get a little bit worried about some of those investments. And again, you saw those peak out almost a couple quarters ago. And there's a rolling over pretty substantially. And you continue to roll over. So the weakness that I think we could have seen coming from the private debt markets, whether it's BDCs or from private debt funds themselves-- I think you would have already started to see that manifest in some of these banks taking a little bit more precautionary measures to cushion against that. And we're just not seeing that right now. So again, you hit it right on the head when you introed this whole-- this section, Brian. I think a lot of what we're hearing and seeing within the private debt markets are really more idiosyncratic. I'm not sure this is the tip of the iceberg in terms of leading to something more sinister-- i.e., maybe a systemic risk across the banking system-- so I think, again, something that-- paying attention to. But I think that risk is at least contained right now and not something that we should be spreading and creating concerns across the debt markets. 

BRIAN HESS: Thanks, Jack. And so I guess in summary for the call as a whole, we're not too concerned about credit deterioration in the economy, not too concerned about excesses within AI. We're watching that closely. And sure, there are pockets of it. But overall, we don't see too much excess yet-- not overly concerned about inflation being above target, and we do think shelter inflation can help bring it back down closer to target, but still keying on the labor market as the one-- probably the biggest risk and the area where we're most worried about deterioration. Is that fair? 

JACK JANASIEWICZ: Ho-hum. 

BRIAN HESS: All right. That does bring us to the end of our webinar today. Thank you, Jack and Garrett, for the insightful commentary and charts, as always. And thanks so much for our viewers for joining us. We wish everyone a happy holiday season. And we look forward to continuing the dialogue next year. 

If you do have any questions as a followup to today's call, just please reach out to a Natixis salesperson. Thanks again, and we'll see you soon.