Highlights:
• Job security has the potential to replace inflation as consumer’s biggest concern in 2026. The US has picked a number of trade fights. It is not clear they are winning any.
• December saw the Federal Reserve and Bank of England reduce rates, the European Central Bank hold rates steady, and the Bank of Japan increase rates.
• China’s manufacturing-driven economy showed resilience in the face of U.S. tariffs last year, but underlying issues that include insufficient job opportunities for young people, a sluggish housing market, and lackluster consumer spending continue to pose challenges.
• Adhering to an investment policy based on time and not timing, as well as diversification, remains the best way we know to deal with uncertain markets and volatility.
Commentary:
“In investing, long-term money success is about being able to absorb manageable volatility; if you can’t do that, you’re pushed into the much harder trick of attempting to avoid short-term volatility. You’re only durable when you care more about surviving than looking dumb for getting hit by it in the first place. Instead of trying to look smarter than everyone else, you make a quiet long-term bet that things will slowly get better over time.”
-Morgan Housel, The Art of Spending Money
Consumers continue to lift the U.S. economy, even as inflation remains higher than the Federal Reserve’s (Fed) 2% target and hiring remains sluggish. But consumer spending remains uneven, with growing signs that lower-income Americans are struggling. The most recent gross domestic product (GDP) report showed that inflation-adjusted disposable personal income was flat which indicates that income is barely keeping up with inflation. The measure is after taxes and excludes capital gains, which have buoyed mostly upper-income households who can afford to invest.
As we head into 2026, job security could soon replace prices as consumer’s biggest worry in what is currently a low hire, low fire labor market. The unemployment rate has drifted higher to its highest level in four years, and fewer employees are quitting their jobs. Outside of the most recent recessions (Great Recession and COVID-19 recession), 2025 saw the lowest pace of average monthly job growth since 2003. Business leaders seem to be optimistic about growth and pessimistic about hiring. While companies did not resort to full-scale layoffs in 2025, many did trim head count and stop hiring after spending much of the year juggling steady consumer demand with uncertainties surrounding tariffs and the impact of artificial intelligence (AI) on their workforces. Most new technologies create more jobs than they destroy overtime, but there’s often pain in the short-term. Time will tell if AI fits this pattern or if this time is different.
As demand for workers eased, employers did not need to offer the same lofty pay raises as in the years immediately following the pandemic and this led to wage gains slowing throughout the year. For the Fed, cooling wage gains are an encouraging sign that inflation remains in check, but this is little comfort to workers who are trying to stretch their income after years of high inflation. Responding to the softening of the labor market and stubborn inflation, the Fed cut interest rates for a third straight meeting in December but signaled they might be done for now amid unusual divisions within the Federal Open Market Committee over the path forward.
The decision to reduce the benchmark federal funds rate by a quarter point brought the rate to a three-year low of between 3.5% and 3.75% and was aimed at protecting against a slowdown in hiring that was sharper than anticipated. With progress on inflation stalled, Fed officials indicated that further rate reductions may require evidence of labor market deterioration. “We’re well-positioned to wait and see how the economy evolves from here,” said Fed Chair Jerome Powell. December’s annual inflation reading showed no change from the previous month, leading speculators to believe that that the Fed is unlikely to change interest rates at its next meeting.
Like their counterparts at the Fed, the U.K.’s central bank is seeking to balance above-target inflation against a cooling jobs market, and its members similarly hold differing views about how quickly borrowing costs should fall. The Bank of England (BOE) cut its key interest rate in December to a three-year low of 3.75% from 4%, resuming a series of cuts that stretch back to August 2024 after a pause in November. The BOE indicated that borrowing costs are likely to fall further in the coming months but are approaching their low. “We still think rates are on a gradual path downward,” said BOE Governor Andrew Bailey. “But with every cut we make, how much further we go becomes a closer call.”
On the other end of the spectrum, the Bank of Japan (BOJ) raised its policy rate target to 0.75% from 0.50% at its December meeting, where it had been held since January. This is the highest level in 30 years and represented another small step back from the world’s longest and biggest experiment with ultra-expansionary monetary policy. BOJ officials raised their policy rate target in response to sticky inflation, which is still a painful novelty for households in a country that was battling flat or falling prices for decades.
Meanwhile, the European Central Bank (ECB) opted to hold its deposit rate steady at 2% at its December meeting, where it has been since June. A period of more stable borrowing costs seems to have set in across Europe, where ECB President Christine Lararde reiterated that the ECB is in a “good place,” repeating a phrase she has used often in recent months. Inflation has fallen back toward the ECB’s 2% target and is projected to be below that level in 2026 and 2027 before returning to around that mark in 2028. Growth in the eurozone has held up better than expected in the face of U.S. tariffs, and forecasts now project that the eurozone economy grew 1.4% in 2025 and will expand 1.2% in 2026.
Just recently, the European Union (EU) gave the green light to a sweeping trade pact with four South American countries – Brazil, Argentina, Paraguay and Uruguay – that would create one of the largest free trade zones in the world, connecting markets with more than 700 million people. This agreement with the so-called Mercosur block covers roughly one-quarter of gross domestic product and represents a push for deeper global economic cooperation and is in stark contrast to the United States new approach of coercion in its dealings with other countries. The agreement is expected to cut tariffs on European products exported to South America and on South American goods shipped to Europe.
China’s industrial subsidies and relentless export policies send a message that they are not interested in abiding by free-trade agreements any more than the United States is these days. China also appears to be closing the gap with the U.S. for global technological dominance, indicating perhaps its strategy to boost self-sufficiency in critical sectors as insurance against adversaries cutting off access to foreign technologies is working. Leaders are signaling that the immense costs of this technological investment are worthwhile, especially as relations with the U.S. remain volatile and the U.S. continues to impose limits on selling advanced semiconductors to slow down China’s AI development. The problem is that, to this point, tech investments and state subsidies are flowing to sectors that are not creating enough jobs, with some estimates showing that one out of six young people in Chinese cities is out of work.
The pursuit of self-reliance through state spending has deep roots in China, dating back to when Chairman Mao Zedong championed technological independence in the 1950s and 1960s as relations deteriorated with the Soviet Union. One key difference now is that China has vastly more resources to achieve its self-reliance goals, from many of the world’s leading scientists and engineers to the foreign capital flowing in from its trade surpluses.
However, big parts of China’s economy continue to be a mess. The technological gains are coming at a steep cost, with the hundreds of billions of dollars China spends each year on domestic technology eating away at money needed for rural education and reinforcing the social net and other programs many economists say are needed to put growth on firmer footing. The housing market continues to be a drag on China’s economy, adding to uncertainty over China’s economic future that has left many people cutting back on spending. That has forced companies to cut back on hiring and left wages depressed.
For now, however, the government seems determined to export its way out of trouble instead of upending China’s economic model. By keeping its currency weak and pursuing self-reliance to replace imports, the country’s trade surplus topped $1 trillion in goods for the first time ever in 2025. This represented a 20 percent increase from 2024 and was the world’s largest trade surplus ever, demonstrating the resilience of China’s manufacturing ecosystem in the face of Trump’s tariffs and allowing China’s economic growth to defy expectations. Such a strong year for manufacturing and exports also suggests U.S. efforts to contain China’s economic and strategic ambitions and weaken its grip on essential global supply chains are falling flat. Growing shipments to Asia, Europe, Latin America, and Africa offset the hit from Trump’s levies on direct sales to the U.S. However, the head of the International Monetary Fund (IMF) warned that China is too large to rely on exports for growth and that the country’s manufacturing dominance risks exacerbating global trade tensions. The IMF has urged China to take greater action to shift its economy toward domestic consumption.
As we head into a new year, investors are worried about the current state of the world and questions about AI circular funding, valuations, and spending. There is nothing wrong with worrying so long as it does not impact your investing strategy and become an impetus for trying to time equity markets. It is also helpful to remember that it is human nature to focus on what is wrong with the economy and lose sight of all that is right. We continue to stress the importance of developing and sticking to an investment policy that is consistent with your anticipated portfolio withdrawal requirements and risk tolerance as the best way to deal with uncertain markets and volatility.
Staying the course has been easy for much of the last 16 years, but to be a successful investor over the long term you need to stick to your investment policy during tough times which we will almost certainly encounter again in the future. To quote Warren Buffet, the greatest investor of our generation who retired as CEO of Berkshire Hathaway on December 31, 2025, “predicting rain doesn’t count, building arks does.” In our opinion, the best ark for an unstable world remains a well-balanced and diversified portfolio.
Urban Financial Advisory Corporation – January 2026
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