How likely is a recession in 2026?

2025 was a strong year for investors across major markets. But it was also a year where talk of recession ramped up, prompting many of our clients to ask: What are the chances of recession in 2026?

Before addressing these concerns, let’s clarify what a recession entails. Technically, it’s defined as a significant, prolonged downturn in economic activity, usually measured by two consecutive quarters of negative gross domestic product (GDP) growth. Now, let’s explore the key questions shaping the recession outlook for 2026.

An economic cycle describes the recurring pattern of GDP growth accelerating, slowing and contracting around a trend rate over time. We believe that most economies – including the UK and U.S. – are in the later stages of the economic cycle. This is because there’s limited spare capacity that can be employed to drive growth. For example, unemployment rates are close to what economists believe to be ‘full employment’ and labour force participation rates are probably not going to rise much further. Economies can continue to expand from ‘structural’ growth – namely labour force and productivity growth. But there doesn’t appear to be much scope for ‘cyclical’ growth.

While there are moving parts, our sense is that for now, we won’t see much change in the potential growth rate of economies like the U.S. and UK over the next several years.

In the U.S., the Trump administration’s immigration clampdown is holding back labour force growth. However, productivity gains from rising AI adoption could offset this.

The UK faces similar challenges, with slower immigration growth reducing labour force growth. AI adoption should support productivity, but there are uncertainties about how quickly and the magnitude of its impact. For instance, the Office for Budget Responsibility expects just a 0.2% annual productivity boost from AI over the next five years.

While there are moving parts, our sense is that for now, we won’t see much change in the potential growth rate of economies like the U.S. and UK over the next several years.

Interest rates have fallen from recent highs in both the U.S. and UK, supporting economic growth. Our view is that long-term interest rates and bond yields are probably not going any lower in the U.S., but they have scope to decline a little further in the UK as inflation converges lower with most other developed economies.

On the fiscal front, the Republicans passed a large package of measures in mid-2025. This primarily extended expiring tax cuts and slashed Medicaid and other spending, limiting its growth impact.

In the UK, the Labour Party outlined an Autumn Budget that’s set to boost government spending over the next few years, funded by tax rises in later years. We don’t expect the measures to meaningfully change the trajectory of the UK economy, but the positive reaction to the Budget from the UK bond market (gilt yields fell) should provide some moderate support to growth.

Tariffs temporarily protect domestic industries but raise consumer prices, reduce competition, disrupt supply chains, and limit the Federal Reserve’s ability to cut rates. The broader economic costs typically outweigh the short-term gains.

The impact of tariffs on global growth has been weaker than many economists feared, so far at least. This reflects President Trump’s softened stance and limited retaliation from U.S. trade partners. Nonetheless, the situation warrants close attention.

Despite the lack of room for cyclical growth and the risks stemming from higher tariffs, we don’t see a recession in 2026 as a base case scenario.

Commercial bank lending to what are called non-depository financial institutions (such as private credit funds) has surged over the past decade. It’s against this backdrop that the bankruptcies of auto parts supplier First Brands, and subprime auto lender Tricolour have spooked investors.

That said, there are several reasons to be cautiously optimistic that we aren’t on the cusp of a new credit crisis. Private sector balance sheets are healthy, banks are well capitalised, and lending standards remain prudent across most loan categories.

There are signposts we monitor that have historically provided advance warnings of a recession:

• Credit spreads (the difference between corporate and government bond yields) often widen ahead of a recession, as traders become worried about rising default risk. While credit spreads are off their cycle lows, the widening has been minimal.
• Yield curve slopes (the difference between long-term and short-term government bond yields) usually narrow or flatten to signal rising risks. At present, yield curve slopes in most bond markets have widened/steepened, which is encouraging.
• AI-related investment has been a big driver of growth this cycle, but a slowdown would alter that trajectory – we’re monitoring this closely.
• Economic feedback loop – normally, economic expectations drive the equity market. But the order can sometimes reverse. If stocks drop sharply (say, over valuation concerns), the resulting confidence and wealth effect (where investors consume more when asset prices rise and vice versa) could spark a recession.

Despite the lack of room for cyclical growth and the risks stemming from higher tariffs, we don’t see a recession in 2026 as a base case scenario. Here’s why:

• Inflation and interest rates have moved lower.
• Household and business balance sheets are in good shape, which isn’t often the case heading into a recession (2001 and 2007 are notable examples).
• Global excesses are manageable – while excesses (such as government debt) and imbalances do exist, they’re not too severe, in our view.
• AI investment stays robust – while there’s a risk of AI-related spending moderating, most of the companies doing all this investment report that it’s still not enough to keep up with demand.

Recessions are often driven by shocks, which are difficult to predict. The U.S. as an example, five of the eight U.S. recessions since 1970 involved shocks (three oil shocks, a terrorist event, and a pandemic), which were hard to see coming.

This cycle, a similar shock, or a new one – whether an escalation of trade wars, a military war (such as China invading Taiwan), or an entirely new crisis – could spark a recession.

But shocks aren’t the only recession catalysts. For example, if inflation were to re-accelerate, forcing central banks to raise interest rates anew, that would raise recession risks. And while private sector balance sheets are in good shape, government balance sheets are stretched, implying less room for additional fiscal policy to support economic growth.