Executive Summary
As of Q4 2025, the U.S. economy remains mired in a prolonged “Sluggish” macroeconomic regime characterized by below-trend growth, stable inflation, and easy financial conditions.
The signs that this regime may finally be coming to an end in the next 12 months are beginning to show. Activity is losing momentum, and inflation is back on an upward trend (with tariff impacts to hit in earnest around the turn of the year). Meanwhile, the Fed is indexed on employment and has gone into easing mode, spurring asset valuations to stretch even further from fundamentals.
Reflecting the notion that a change in the macroeconomic landscape is overdue, we now assign a weight of 45% to Scenario 1, in which the economy remains the current Sluggish regime for the next 12 months. This is still the modal scenario, but its probability has fallen below 50% and it’s now less likely than something else happening.
We see two main alternative paths that the economy can take, depending on how the financial sector evolves. In Scenario 2 (35% weight), the AI bubble pops, triggering a sudden stop in investment and then spending. The economy is not overleveraged, so the crisis is shorter and shallower than in 2008. On a longer-term basis, the collapse resets valuations and clears macro imbalances, setting the stage for a durable recovery.
Scenario 3 (20% weight) is almost the reverse sequence of events. Here, there is no crash. Instead, the Fed continues to ease over the next six months, overstimulating the financial sector and getting behind the curve on inflation. This leads to a short period of overheating before inflation rises beyond even a dovish Fed’s tolerance, requiring a policy reversal that tips the economy into a Stagflation regime, made worse by a continually increasing public debt.
The options on the menu are “muddle on without treatment”, “take your medicine and recover quickly,” or “misdiagnose a chronic disease.”
We also provide analysis of the global secular themes that form the backdrop against which our cyclical scenarios unfold. These themes give additional rich context to the scenarios and will determine the degree to which markets and industries behave differently from similar past situations.
- Global trade, industrial policy, and geopolitics: Drives inflation and growth via tariff policy, influences investment patterns, and shapes global capital flows.
- Public debt, interest rates, and inflation: Soaring public debt burdens anchor long-run higher interest rate and inflation expectations, marking a break with the “lower for longer” post-2008 norm.
- AI investment and downstream effects: Accelerates or attenuates growth, inflation, and labor market dynamics depending on the degree of adoption and the extent to which employees are replaced or augmented.
For the full analysis and detailed scenario descriptions, please download the report.