Fed preview, AI bubble risks for households and a softening tone on tariffs – for now

After several weeks of mixed messages and internal disagreement, Federal Reserve officials now appear aligned on delivering a 25bps rate cut at the next meeting on 10 December. With the unemployment rate likely to rise a little further through Q1 2026 and persistently weak job creation, we expect another 25bps cut in the first half of 2026 (most likely in March) as the Fed continues to prioritize labor market risks. However, sticky core inflation and strengthening underlying growth momentum – generated by loosening fiscal and financial conditions as well strong AI-related capex – should eventually keep the Fed on a prolonged hold, with the Federal Feds funds rate expected to settle at our long-standing view of 3.5% (upper bound). Our financial conditions indices show that ’risky’ financial conditions (credit spreads, equity markets) are particularly loose in 2025 relative to historical averages. Historically, financial conditions have helped to predict near-term future economic activity and they signal an increasing growth-boosting impulse in the quarters ahead.

US households have significantly benefited from the AI-driven stock market surge, with the S&P 500 rising 74% over the past three years, largely powered by a small group of AI stocks. Because households hold 65% of their financial savings in equities, pensions and mutual funds, their gross financial assets rose nearly +28% (USD30.6trn). This heavy exposure to equities likely boosted confidence and spending during the rally but it also creates vulnerability: A market correction could quickly reverse sentiment and in turn weigh on GDP. Economic fragility is worsened by the increasingly k-shaped structure of the US economy, with the top 10% of households owning 87% of total assets invested in corporate equities and mutual fund shares, and 67% of total net wealth, while driving about half of retail spending. In our baseline scenario, we expect a short-lived 15% correction in the S&P500 in early 2027, driven by earnings misses, to shave -0.2pp off annual GDP growth. In a downside scenario mounting fundamental concerns about the AI business case, triggered by more significant earnings misses of US chipmakers and cloud providers, would result in a -25% correction. This would wipe out USD16trn in household wealth – equivalent to an almost -8% drop in total net worth – and reduce US GDP growth by -1.6pp, sending the economy into recession.