SUMMARY
Fiscal and monetary support are increasing amid economic resilience. We see investment potential in the likes of select cyclical assets.
KEY TAKEAWAYS:
We see improving US liquidity and global fiscal policy becoming more supportive
Lower rates and increased liquidity may help economic growth in 2026
We thus believe the backdrop for more cyclical financial assets tied to natural resources
We expect well-underwritten private credit strategies to remain attractive for investors able to own less liquid assets
Private credit manager selection is key as dispersion rises
The Fed will be shifting its liquidity settings to be more accommodative
Our investment process is built on marrying macro, fundamental, holistic flow, and valuation dynamics – and U.S. monetary liquidity is a key input into the macro landscape.
At inflection points, liquidity – the ease in which corporations and households can access capital – is a powerful driver of market directionality.
The relationship between changes in money supply growth combined with Fed balance sheet shifts and S&P 500 returns one year later can be highly significant, particularly around large packages during recessions.
However, small adjustments also influence markets, and the Fed is moving towards one of those inflection points.
Recent stress in the funding markets, evidenced through spreads in overnight financing rates, indicates a shortfall of liquidity in the system.
As these spreads widened, Fed officials have signaled their awareness that the system needs more cash to function smoothly and will move from Quantitative Tightening (QT) to small purchases.
There is debate around the timing and magnitude of this adjustment (Citi Research expects this shift in early 2026), though policy action could begin as soon as this month.
More accommodative liquidity settings coupled with deregulation and strong bank balance sheets create a solid foundation for additional bank lending in a continued stable economic growth environment.
Loans and leases relative to deposits are low relative to pre-GFC1 levels and have room to rise as rates come down and demand for credit increases.
Banks are slowly doing less tightening of lending standards for firms and consumers, which we expect to continue into 2026.
Overall, the foundations are set for healthy leverage growth in 2026, providing an additional reason for optimism around activity in the new year.
Bottom line: An improving liquidity and credit creation environment is further supportive of resilient nominal growth in 2026. While we expect above-target inflation to constrain ongoing rate cuts in 2026, lower policy rates and more accommodative liquidity settings will likely aid cyclical tailwinds.
Portfolio implications: Stay invested, add diversification, lean into cyclical tailwinds
The global macro backdrop, industry fundamentals, and asset class flows support natural resource plays into 2026.
An aggressive capital expenditure pipeline and shifting needs for AI infrastructure are set to drive robust, ongoing demand for natural resources, specialized labor, and niche industrial suppliers.
Whether viewed via the earnings transcript or corporate survey lens, U.S. capital expenditures (capex) are on track to reach new highs in 2026 when normalized by real GDP. Across the G10, capex is similarly rising as nations invest in AI-related infrastructure.
Additionally, global fiscal trends are expanding, not contracting, while monetary policy remains accommodative, another source of nominal growth support in the year ahead.
Given this combination of improving liquidity, resilient nominal GDP growth, and strong upstream demand, we see a supportive backdrop for more cyclical financial assets tied to natural resources.
When we overlay our holistic flow analysis, we see opportunities for inflows to return to these asset classes following the outflows seen during the Fed’s aggressive 2022 rate-hiking campaign.
Earnings revisions are inflecting higher in this corner of the market, reinforcing their complementary role within our asset-allocation framework.
Bottom line: Seek to maintain core AI exposure, stay invested through volatility, and consider adding resource-linked cyclicals to capture the next leg of the liquidity-supported growth cycle.
Private credit: Not seeing broad-based deterioration, but manager selection is critical
There has been a growing chorus of concerns around private credit lately with the rapid pace of growth of the asset class in the past few years, increased prevalence of payment-in-kind optionality for borrowers, and several recent high-profile bankruptcies all contributing to the noise.
While we acknowledge the validity of these datapoints as potential warning signs and key areas to monitor going forward, we think the negative narrative has become somewhat overblown.
We track a variety of metrics across the BDC sector to gauge the health of private credit given BDC assets have grown to represent roughly 30% of the market2.
Overall, we find that asset quality metrics across this space remain healthy. Importantly, the fact that BDC structures themselves are typically low levered (despite lending primarily to highly levered, private companies) provides significant cushion to absorb a material potential increase in credit stress.
Further, as we highlighted in last week’s bulletin, credit trends across the banking system have been stable to improving in recent quarters and the sector remains well capitalized, helping to alleviate fears of possible contagion risk stemming from private credit.
Bottom line: Despite some indications of increasing credit stress in pockets of the private credit market, we have seen limited evidence of broad-based deterioration.
We continue to believe that an allocation for suitable and qualified investors to private credit makes sense for portfolios with flexibility to own illiquid assets but emphasize the importance of focusing on managers with differentiated origination, underwriting, and workout capabilities given our expectation for growing dispersion in performance across the asset class.
