December 2025
In the early days of January, many market participants forecast how they expect the economy and the capital markets to perform in the coming year. That’s especially so this year given that the S&P 500 index is trading at a record high and has just completed the third consecutive year of double-digit returns, with two of the three seeing gains of more than 20%. Those with a vested interest in the status quo, i.e. banks and money managers, are usually sanguine about the outlook. With that in mind we explore the fundamental backdrop of the economy and what we think could go right or wrong this year.
To start, we look to the consumer and the retail sales tally published by the Census Department. Due to the government shutdown the most recent retail sales report is for November and showed a robust month-over-month gain of 0.6%, with all categories showing strength. That meshes with what retailers have described as having healthy year-over-year holiday sales growth.
The hope is that retail spending will carry over into this year. With the changes in the tax code and the expectation that the average tax refund with grow this year, the expectation is that money will get spent. What doesn’t seem to support consumer spending is the sentiment indices. The last reading of the University of Michigan current conditions index was 52.4, that’s just above the 50.4 low that was touched last month. Much of the disconnect is attributable to the Donald Trump effect and it’s a dramatic one. In the January 2026 current conditions survey Republicans scored 96.3, while Democrats rated the economy 38.1. One year ago, at the start of Trump’s term, the divergence was significantly more narrow with Republicans totaling 86.7 while democrats came in at 65.0. In effect the survey has become a bipartisan referendum on Trump’s performance as President and less of a measure of the consumers propensity to spend.
Turning to inflation there’s both good and bad news. The good news is that inflation is well off the recent peak of 6.6% year-over-year inflation that was recorded in September 2022. Core year-over-year CPI in December, the most recent measure, was 2.6%. The bad news is that we don’t think it’s likely to fall much below that reading and is more likely to tick higher. Namely, the retail spending we just discussed is likely to be supportive of price hikes at retail outlets. Moreover, Trump’s insistence that the Fed cuts rates aggressively is likely to stoke inflation. It’s a paradox of the bond world that easy money is a precursor of inflation and to compensate for heightened inflation risk, bond investors demand a higher term premium. In bond parlance it’s called steepening of the yield curve. Exacerbating the trend toward a steeper yield curve is Trump’s insistence that the President have a role in setting monetary policy. It’s in the interest of the sitting President to have a robust economy during his tenure and not to worry about the longer-term effects once the overheating cools.
The last variable and the one most opaque is the employment situation. Clearly employment growth has slowed as we saw in the deceleration last year. In 2025 the average monthly job gains totaled 65,000 workers a month, that’s exactly one half of the 130,000 monthly job gain recorded the year before. This is a critical piece in the economic growth puzzle. If net job gains go from positive to negative, everything we just discussed is at risk, with the likely outcome being an economic recession. That’s not what we’re forecasting, but it is something we’ll be on the lookout for as the year progresses.
