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The year 2025 showcased resilience in global markets despite trade frictions and geopolitical uncertainties. Gold, Equities across developed and emerging markets (EM), and EM fixed income delivered strong returns, with global assets outperforming Indian markets. As we move into 2026, the backdrop is defined by fiscal expansion, AI-driven investments (and the risks thereof), divergent inflation trends, central banks on final legs of easing and soft dollar.

Global trade and growth defy tariffs in 2025

Global growth surprised on the upside in 2025. Loose fiscal policies across major economies cushioned tariff impacts, while AI-related investments in the U.S. provided a significant boost. Despite de-globalization rhetoric, global goods exports surged 13% during 9M 2025—the second highest since 2000. The U.S. goods trade deficit widened to a monthly average of $112 billion versus $102 billion in 2024.

Lopsided trade deals between US and other nations; India-U.S. talks ongoing

Several nations entered asymmetric trade deals with the U.S., though formal agreements are lacking. India- US negotiations are still going on. Meanwhile, India signed bilateral agreements with the UK, Oman, EFTA (Switzerland, Norway, Iceland, Liechtenstein), and New Zealand in 2025, reinforcing its global trade positioning.

US Economy: AI Investment Masks Underlying Weakness

Looking ahead, we are in an unusual scenario in the US with strong capex but weak labour market. AI and data centre investments dominate U.S. growth, but excluding AI, underlying growth remains modest. Employment trends remain weak, with non-farm payroll additions slowing and consumer loan delinquencies rising across mortgages, student loans, and credit cards. Fiscal support persists, with deficits above 6% of GDP under the One Big Beautiful Act, ensuring continued stimulus. Yet, sustainability of AI-led growth is uncertain.

Europe: Fiscal expansion after years of austerity

Europe has shifted gears from austerity to expansion. Germany’s Euro 1 trillion infrastructure and defence initiative marks a decisive end to a decade of fiscal restraint. This expansionary stance provides a modest growth impulse, though structural challenges remain. Trade tensions with the US have subsided following new agreements, removing a major source of uncertainty. Inflation in the euro area remains close to 2%, suggesting limited risks compared to the US.

China: Export Dependence and Weak Domestic Demand

China’s economy weakened in 2H 2025 as real estate, consumption, and investment slowed. Retail sales growth moderated, property prices fell further, and consumer confidence remained weak despite fiscal measures. Housing, which accounts for 60% of household assets, continues to drive sentiment, and without major housing stimulus, wealth effects will stay subdued. Beijing’s 15th Five-Year Plan aims to boost household consumption, but this requires deep reforms in income distribution and social welfare. Until then, exports remain China’s primary growth engine, reinforcing its role as a global deflationary force. For investors, China will not drive a significant global recovery in 2026. This places the U.S. as the key growth driver, where the outlook is increasingly complex.

The analyst fraternity has been proven consistently wrong in calling out for recession in the US. The current cycle is quite different in the sense that historical lead indicators of recession has failed to work in the current cycle (such as PMI, Non-Farm payrolls, yield curve inversion). So, for now, we work with an assumption that US and the overall global growth would stay supported in 2026. Risks emanate from further weakness in job creation and any potential fractures in the AI space.

Sticky inflation in the US, moderates elsewhere; Central banks easing limited in 2026

Inflation remains a pressing concern in the US, while deflationary impulses from Chinese exports and a contained commodity prices dominate elsewhere. Most central banks, except those in Latin America, appear to be in the final phase of monetary easing. However, there remains some buffer for further rate cuts, particularly among emerging markets, should global growth weaken.

Dollar Outlook: Softening Bias Continues

The U.S. dollar, strong early in 2025, but weakened from April amid tariff uncertainty. While fears of structural decline surfaced, fundamentals regained prominence as trade jitters eased from July. Historically, Fed rate cuts outside recessions—similar to now—align with dollar weakness. The dollar’s trajectory in 2025 mirrored patterns seen during Trump’s first term, reinforcing expectations of continued softness. Key drivers include global growth resilience, Fed’s accommodative stance, and loose U.S. financial conditions. The magnitude of Fed cuts and leadership changes at the central bank will be critical in shaping the dollar’s path through 2026. Emerging markets may benefit from softer dollar conditions and supportive liquidity.

India’s growth outlook

India’s economic growth was soft FY26. Statistically, even as RGDP averaged 8% y-o-y in 1H, though nominal growth was subdued at 8.8%. For FY26, nominal GDP is expected at ~8.5%, while real growth could appear elevated at 7.5% due to deflator effects. Again, statistically, FY27 should see nominal growth improve to ~11%, with real growth moderating to ~7.2%. But directionally, we are constructive on growth. Domestic drivers—credit-led consumption and policy support—will dominate as exports remain weak. Structural reforms and premiumization trends reinforce a constructive medium-term outlook, though global slowdown and geopolitics remain key risks. Rural spending outlook is modestly positive as welfare measures and low inflation mitigate kharif income setback. A positive development of India US trade deal could only be mildly positive for growth outlook as the country still faces a stiff competition from rising dominance in Chinese exports.

Policy Pivot: Growth orientation by both RBI and government

RBI cut the repo rate by 125 basis points and infused liquidity (or announced liquidity infusion) of ? 15.7 trillion between December 2024 to December 2025, signalling a shift toward growth orientation. Fiscal stance eased, and reforms accelerated.

Credit Revival: Positive impulse to India’s growth outlook

Bank credit growth rose from 9% in May 2025 to 11.4% by November 2025 and could improve to 13-14% in FY27. Household credit could outpace corporate credit. Sectors reliant on credit-driven demand and premiumization trends are expected to outperform.

Corporate capex is driven by expansion in utilities and cement sector

Corporate capex remains healthy (early teens), driven by power, gas transmission, capital goods, and cement which in turn is thriving on urban real estate pick-up. Central capex is expected to align with nominal GDP as fiscal consolidation moderates.

Inflation could mean revert to 4% in FY27; RBI’s liquidity action would be more critical.

Inflation is expected to average ~4% in FY27, still benign. While we would not rule out one more rate cut in 2026, monetary policy in India is likely headed for a long pause (unless global growth outlook deteriorates). Liquidity, however, would continue to stay supportive. Just at the close of the year, RBI announced another round of OMO totalling ? 2 trillion to be executed in January 2026 and USD 10 billion of buy sell swap in mid-January.

Government bond demand supply could remain tight in FY27

Fiscal deficit is projected to ease to 4.2% in FY27 from a likely 4.4% in FY26, though state deficits remain elevated (marginally above 3% of GDP). Government bond supply could rise to Rs. 29 trillion, keeping demand-supply dynamics tight.

Rupee has been the focal point in 2025- depreciating nearly 5% in 2025

Rupee witnessed significant depreciation in November despite the U.S. dollar index (DXY) showing a 9% decline and most emerging market currencies appreciating against the dollar. Typically, India’s lower inflation relative to the U.S., stable crude prices, fiscal discipline, and Current account deficit under 1% of GDP support Indian assets and the rupee.

No trade deal is at the helm of this mayhem. Weakening sentiment around rupee triggered panic among importers, prompting a rush to hedge future dollar liabilities. This surge in hedging demand has pushed up forward premiums in India and driven the Indian fixed income yields higher too.

Constructive Outlook on Rupee

The INR’s recent weakness, despite low inflation, has made the REER competitive. We expect improvement in Balance of Payments in FY27. High gold imports bill, driven by 60% higher prices (despite some cut in volumes), are offset by weak oil prices. While the Non-oil Non gold import has widened due to economic recovery and Chinese export competition, strong double-digit growth in net services exports helps contain the current account deficit below 1% of GDP in FY26 and FY27. Capital inflows should improve in FY27, supported by potential inclusion in yet another global bond index and an expectation of resumption of FPI equity flows. After ~5% depreciation in 2025 and ~4% FYTD, we expect the rupee to weaken only ~2% in FY27 (to 92/USD). A trade deal could even trigger modest appreciation. Overall, currency fundamentals remain stable, aided by contained CAD, resilient services exports, and hope of improving capital flows.

Equity outlook: constructive but selective for CY26

CY26 looks constructive but selective. Key drivers include stronger bank credit growth, and revival in FPI/FDI flows. Consumption should rebound on healthier household finances and policy support, while corporate capex sustains mid-teen growth in power, real estate, and data centres. Exports stay muted, making domestic demand the main engine. Valuations have corrected somewhat in 2026, yet remain elevated, so sectoral selectivity is vital. We favour companies with strong balance sheets, pricing power, and domestic exposure. Risks emanate from global shocks and geopolitics. Bottom-up focus on consumption, financials, and select industrials would be the key.

Fixed Income Outlook: prioritise stability and accrual over a directional duration strategy

Given the overall macro and demand dynamics in the current phase of the rate cycle, it is time to prioritise stability in the fixed income space and accrual over a directional duration strategy. A moderate duration stance, with core accrual built around high-grade short tenor AAA bonds and selective exposure down the curve (consistent with fund risk mandates) is warranted in portfolios. Duration remains tactical in the current environment.

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