Cautious optimism for 2026

Welcome to the Federated Hermes 2026 outlooks series. Over the following weeks, our thought leaders and portfolio managers in liquidity, fixed income and equities will discuss what the new year might bring for the economy, financial markets and investors.

Stephen Auth, CIO, Equities 

Could 2026 herald a new era for equities?

Productivity gains, renewed economic growth, margin expansion and recently released "animal spirits" — accompanied by benign central bank policy — are all driving global markets higher. Federated Hermes has upgraded its forward earnings outlook and we’ve also increased our 2026 S&P 500 price target from 7,500 to 7,800.

Here’s how we think we’ll get there:

1. Nominal GDP growth should accelerate in 2026. Given an expected inflation rate of 2.5%, we believe nominal US GDP should run north of 5% in 2026 and 2027.
2. The labor market should remain ‘not too soft, but not too tight.’ With the Fed now in a (belated) cutting cycle, we expect employment to pick up.
3. AI productivity gains should begin to accelerate. Across the world, companies of every stripe are incorporating the AI revolution into their work processes, likely unleashing a new era of productivity gains.
4. Inbound investment to the US should be a new driver. In our visits with corporate management, company after company said they are particularly focused on this issue, and not just in relation to the US but also elsewhere.
5. The Fed is in a new cutting cycle. With rates at 4.25% against a core inflation rate of 2.5%, the US Federal Reserve has a long way to go in this easing cycle. Although the broad economy is not as rate-sensitive as it once was, certain sectors are – and they have been in a two-year recession. Relief here will be a rocket booster to overall growth.
6. Corporate margins should continue to expand due to ongoing economic mix shift, along with widening AI investments. Over the last decade, it’s been common to hear warnings of “peak profit margins.” Although margins have vacillated, the long-term trend suggests that, in fact, corporate profit margins have steadily increased over the last 20 years by an average 4% per year. When you add it all up, we think it’s time to acknowledge that the base case is continued margin expansion, not “peak margins.”
7. ‘Animal spirits’ are heating up. The pick-up in M&A announcements, rising IPO activity and the bounce in confidence surveys all augur well for forward activity.
8. Earnings are on track to reach nearly $400 by 2028. When you factor in even relatively conservative margin gains ahead, alongside rising top lines due to higher nominal GDP growth and the ever-improving profitability mix of the companies that make up the US stock market, we believe earnings for the S&P are looking pretty solid.
9. The market multiple should also grind higher. As we first noted in our equity market outlook for 2025 and 2026, when you adjust appropriately for the recent mix shift in the S&P toward tech firms, a fair multiple for the overall index these days is probably around 22x. This is considerably higher than the long-term average of 18x when the S&P was a more industrial-oriented index.
10. Which brings us to our long-term market target. When you add all the above up, we think a reasonable two-year S&P target is close to 8,600, implying an annual gain north of 14%. This level of return is a bit lower than the 17% annual return for the S&P over the last five years of the post-pandemic recovery but higher than the long-term annual return on stocks of 12% over the last 50 years. 

As we’ve written in our latest update, however, markets rarely move in a straight line, and there’s no question that there are sources of near-term volatility. What’s also clear, though, is that too often investors get so caught up in the day-to-day that they miss the bigger picture. That picture is one of a reaccelerating global economy where owners of the best companies own, in effect, a share of this expanding pie. No surprise, then, that patient investors are likely to be rewarded as the economy — and the profits it inevitably produces — continues to expand. Welcome to the One Big Beautiful World. 

Deborah Cunningham, CIO, Global Liquidity Markets

What is a contrarian view you hold for the coming year? 

That the US Federal Reserve will remain independent. The Trump administration’s relentless criticism of Fed Chair Powell has led many to think the president will erode the long-held insulation the central bank has from politics. Recent actions, such as attempts to fire one governor and the appointment of a White House economist to the board, have intensified that worry in the financial markets. We’re also concerned – but believe that, ultimately, the Fed will prevail, especially given this summer’s Supreme Court ruling that it is a “uniquely structured, quasi-private entity.” 

Although the administration likely will nominate more dovish voting members to join the Federal Open Market Committee (FOMC) — these could include regional Fed presidents, the Board of Governors and, of course, Powell’s successor — we expect the debate about the caliber of the candidates to center on their market knowledge and credentials. The names floated to succeed Powell seem to fit a desire to influence the Fed, but I’m hopeful the Senate confirmation process will focus on their expertise in monetary policy and that this will maintain the integrity of the institution.  

Is the era of low interest rates truly over? 

The administration’s dovish stance has raised concerns that we might return to the long period of near-zero interest rates. We don’t think this will be the case. We expect short-term interest rates to remain in a range of 3-5% based on the strength of the US economy, which should keep inflation above 2%. This is the Fed’s stance, as its latest Summary of Economic Projections (SEP) forecasts the long run level of the Personal Consumption Expenditures Index to be 2%. In other words, the Fed’s intention is, at the moment, to continue to define price stability at that level. The other clue, of course, is its long-run fed funds projection, which is currently at 3%. Changes in Fed leadership and composition of the FOMC likely will not lead to rates around zero anytime soon. 

While it’s too early to be confident about the Fed’s path of policy in 2026 — witness the wide range in predictions in the September SEP — we anticipate some amount of easing to continue. But we believe that the money market funds will remain attractive to investors. Most money fund portfolios hold securities of different maturities bought with the higher rates available before a given Fed cut. This in turn typically causes yields of these portfolios to decline slower than those found in the direct market.

Robert Ostrowski, CIO, Global Fixed Income Group 

What’s your outlook for 2026?

Fixed income markets enter the new year with a surplus of unanswered questions. To be fair, 2025 answered some. A year ago, we expected a repeat of the post-2016 election environment, with a combination of a dovish-leaning Federal Reserve in the short-term and uncertainty about the long-term success of the new administration’s policies resulting in further steepening of the US yield curve. It took longer to evolve than expected. Defying market expectations and growing political pressure, the Fed paused for nine months before eventually resuming interest rate cuts a year into the cycle. Gradually, tariff-driven uncertainty and resultant volatility gave way to investor consensus that the Fed’s dual mandate will be manageable going forward, rate cuts will continue toward a lower fed funds rate and a more dovish Fed and Chair will be in place in 2026.

We wish it were that simple but expect it won’t be — too many unanswered questions remain. Inflation has not spiked as soon and dramatically as expected from tariffs, but neither has it made convincing progress toward the Fed’s target of 2%, remaining elevated and susceptible to tariff impacts (pending Supreme Court action). Employment is softening, but due to significant increases in investment, GDP is solid and the economy is not exhibiting anything near what would normally require the extent of rate cuts currently being "demanded" by the administration. A current contrary view gaining momentum is that the Fed doesn’t need to cut at all, as the economy, at a macro level, does not need stimulation, and risks of elevated inflation remain. The extended bear steepener (short rates falling more than long rates) is evidence of this conflicted point of view in the markets. 

Adding to the mix is a more uncertain US political environment. The recent off-cycle election, dominated by the Democrats in the few key races that gathered the nation’s attention, suggests the 2026 midterms might disrupt the administration’s policy path more than the market is discounting. Midterm US election years have been systematically less positive for risk assets, creating another risk to consider for already-tight credit spreads. Our expectation is that the market may fade US exceptionalism and look to a re-globalization theme, but in an ex-US fashion, i.e., looking to emerging market bonds and currencies.  

The challenge in 2026 will be avoiding the complacency of believing a new normal exists in which policy disruptions including tariffs and irrational AI exuberance are easily absorbed. Though US recession risks appear at bay, the slow-growth economy can easily change direction. Increased unemployment, and spiking inflation, aka stagflation, remain in play over the next year. Credit events and layoffs are also making the news, while critical economic data reporting has been limited. Managing yield curve and duration exposure, as well as finding value across a range of assets that are "priced for perfection" (highly susceptible to downside risks) will continue to be required priorities