2026 Economic outlook: The K factor

Economic growth was surprisingly robust in 2025 despite lots of fireworks in Washington D.C and some pretty challenging periods for the financial markets. We had a painful market sell-off in April after the initiation of the new tariff campaign, but that trend reversed quickly as it became clear the tariffs may not be so bad for the economy after all.

The market recovery really became turbocharged when the Fed lowered rates later in the summer. We even powered through the longest government shutdown in our nation’s history in the fourth quarter. By the time the dust had settled at year-end, we ended up with what was a quite strong year, with great returns for the financial markets.

The Fed’s 2026 multi-faceted dilemma

The Federal Open Market Committee (FOMC) is grappling with the best way to address a complex array of issues, hoping to guide our economy back to a broader, more stable growth pattern that benefits all households and businesses. These included:

Tariffs

The tariff package is most likely to settle in the 15-17% range. Late in the year, it became less certain that the Supreme Court will ratify the existing tariff package. It is broadly presumed that there are numerous backup plans in the wings if the Court strikes down the current tariff package, but the uncertainty surrounding such an event would likely cause turbulence in the markets.

Inflation

Tied directly to tariffs, inflation data has been stuck in a range near 3.00% versus a Fed target of 2.00%. It is also presumed that inflation will push higher during the first half of 2026, as the tariff package becomes more broadly implemented. The Fed is steadfast in its belief that tariff-based inflation is a temporary phenomenon, and that the inflation data will naturally cool off and move back toward the 2.00% target during the back half of 2026. This belief is allowing the Fed to turn its attention to some of the signs of economic weakness and to continue to push interest rates lower.

Growth

2025 enjoyed surprisingly strong gross domestic product (GDP) growth. However, this growth was largely due to import activity intended to front-run the impending tariffs. Consumption numbers were also strong but heavily concentrated within the wealthiest households. It is broadly forecasted that the U.S. economy will experience a period of below-average growth during the first half of 2026. Labor market indicators point toward softness in the broad economy and the spike in activity we saw in 2025 is highly unlikely to be repeated.

The K factor: An economy out of balance

As 2025 unfolded, it became clear that a concentrated group of households and businesses was driving the robust economic activity, lending it the moniker “K-shaped economy‡.” The wealthiest households reside on the upper arm of the “K,” enjoying healthy income gains, rapid gains in wealth and robust consumption growth. The remaining 80% of households reside on the lower arm of the “K,” with job prospects looking paltry, and income and consumption patterns struggling to keep up with the brisk inflation issues.

There is a similar trend within the corporate world. Earnings growth and stock market returns are heavily concentrated within the narrow group of companies at the heart of the artificial intelligence (AI) boom, especially those building chips and hardware for AI and those involved in the massive spending wave associated with construction of the server farms for “hyper-scaler” companies.

Outside of this space, the broad business world has experienced moderate earnings growth and shows little appetite for capital expenditures. The average household desperately needs the average company to show a willingness to expand investment, create jobs and drive wages higher.

Economic risks and opportunities in 2026

By far, the biggest risk to the 2026 economy is the behavior of inflation. The Fed is cutting rates while inflation is too high and rising. UMB and industry researchers seem to agree that the current inflation surge should self-correct by mid-year, and inflation should fall back to 2.5% or lower even as the Fed is cutting rates.

If inflation becomes stuck above 3%, then all assumptions about interest rates will have to be re-calculated, which would cause turbulence for both the stock and bond markets.

While we are thrilled to have enjoyed a stellar year for market returns in 2025—returns that exceeded the expectations of all forecasters—the FOMC has a delicate balancing act on their hands. We believe they will cautiously push rates lower as they look for confirmation that inflation will self-correct back down to a more comfortable zone.

The markets are expecting multiple interest rate cuts in 2026, which may not materialize, but there are other tailwinds in place that should keep the economy and markets moving forward throughout 2026. Given lofty current valuations, we expect market returns to match earnings growth, which should fall in the 8-12% range.

Final notes: Economic look-ahead

We are cautiously optimistic heading into 2026, and respectful of the issues facing us in the coming quarters. We have no reason to foresee a recession heading our way, but economic and earnings growth could be softer than the positive results we’ve enjoyed for the last three years.

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UMB Private Wealth Management is a division within UMB Bank, n.a. (a subsidiary of UMB Financial Corporation) that manages active portfolios for employee benefit plans, endowments and foundations, fiduciary accounts and individuals.

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