For investors navigating an uncertain macro landscape, avoiding the wrong narratives may matter more than predicting the right numbers.
Each year, investors are inundated with forecasts: GDP numbers, inflation targets, interest-rate paths. While those projections can be useful, they often create a false sense of precision. Markets rarely move because a single number was slightly off; they move because investors collectively buy into narratives that later prove wrong.
That’s why, at Payden & Rygel, we approach our annual outlook differently. Rather than trying to predict the future with pinpoint accuracy, we focus on identifying and challenging the most popular narratives shaping investor behavior. The goal is simple: avoid errors. At a recent investor forum in Milan, I walked through ten narratives currently influencing markets and explained why several deserve a closer look as investors head into 2026.
Inflation Isn’t “Stuck”, Tariffs Are Distorting the Picture
One of the most persistent claims in today’s market is that inflation is structurally stuck around 3%. We strongly disagree.
The data show that much of the inflation pressure in 2025 has come from goods prices — and specifically from tariffs. Strip out tariff-related price increases, and core inflation already looks much closer to the Federal Reserve’s 2% target.
More importantly, tariffs represent a one-time price shock. As those effects fade from the data in 2026, inflation dynamics will increasingly depend on services and housing — both of which are already showing signs of cooling. Housing inflation, in particular, recently posted one of its softest readings in five years.
Our base case is that core inflation can plausibly return to around 2% in the second half of 2026, welcome news for consumers, central banks, and bond investors alike.
Strong GDP Doesn’t Mean the Fed Is Done Cutting
Another common assumption is that solid GDP growth will prevent the Federal Reserve from easing further. History suggests otherwise.
While US growth has rebounded sharply — with third-quarter GDP tracking in the 3–4% range, the labor market tells a different story. Job growth has slowed meaningfully, the unemployment rate is drifting higher, and historical experience shows that when payroll growth decelerates this much, it rarely snaps back quickly.
The early-2000s provide a useful parallel. Between 2002 and 2003, the US economy posted respectable GDP growth even as the labor market weakened. The Fed responded by cutting rates aggressively and holding them low until employment conditions stabilized.
As long as labor-market softness persists, strong GDP alone is unlikely to stop further rate cuts in 2026.
Fiscal Deficits Are a Headline Risk - Not the Main Driver of Yields
Concerns about US fiscal deficits have fueled fears that long-term interest rates must remain elevated. While the deficit is large — roughly 6% of GDP — history suggests deficits are rarely the dominant driver of long-term yields.
Instead, inflation expectations play a much larger role. In our framework, fiscal issues primarily affect term premia at the margin. If inflation continues to moderate, longer-term Treasury yields can still move lower, even without a recession.
In our base case — continued growth, easing inflation, and gradual Fed cuts — both front-end and long-end yields have room to decline. A flatter yield curve, while unusual by recent standards, would not be unprecedented.
AI Isn’t a Bubble - Yet
Artificial intelligence has rapidly replaced tariffs as the market’s favorite macro narrative. Some investors now argue that AI spending represents a massive bubble waiting to burst.
We take a more measured view. Technology investment including software, hardware, data centers, and power infrastructure has been a significant driver of US growth for decades. AI has amplified that trend, accounting for an estimated 30–40% of recent quarterly growth.
Crucially, much of this investment is being funded through cash flow rather than excessive borrowing. While we closely monitor corporate leverage, a common precursor to downturns, current debt growth remains modest relative to historical episodes of excess.
Even if AI ultimately proves cyclical, the risk for investors today may be exiting the theme too early rather than too late.
Dollar Weakness Has Boring Explanations
Fears about the end of US dollar dominance have grown louder as the dollar weakened earlier this year. But there is little evidence of de-dollarization in practice.
Foreign demand for US assets — including Treasuries, corporates, and equities — remains strong. Dollar movements have been driven largely by shifting interest-rate and growth expectations, not by foreign selling or a collapse in confidence.
As long as US productivity growth remains strong — supported by innovation, business formation, and technology investment — the broader case for American exceptionalism remains intact.
The Bottom Line for Investors
Our outlook for 2026 is not built on prophecy. It is built on probabilities and on challenging assumptions that could lead investors astray.
In our base case, the economy continues to grow, the labor market softens modestly, inflation cools, and the Federal Reserve continues easing policy. In that environment, fixed income can deliver attractive returns as yields move lower and spreads remain contained.
Even in a more bearish scenario, bonds can provide valuable ballast. The greater risk, in our view, is not a resurgence of inflation but an underappreciated slowdown in the labor market.
For investors navigating an uncertain macro landscape, avoiding the wrong narratives may matter more than predicting the right numbers.
About Payden & Rygel
Payden & Rygel is one of the largest privately-owned global investment advisers, managing approximately $166.6 billion in assets. Founded in 1983, the firm specializes in the active management of fixed income and equity portfolios, serving a diverse range of institutional clients worldwide. With clients that include central banks, pension funds, foundations, and corporations, Payden & Rygel offers a comprehensive suite of investment strategies through separately managed accounts, US mutual funds, and Irish-domiciled funds (subject to investor eligibility). Headquartered in Los Angeles, the firm also maintains offices in Boston, London and Milan. To learn more, visit www.payden.com.
This material reflects the firm's current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results.
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