Economic Letter

By Patrick Pascal

January 2026

U.S. ECONOMY

Unemployment moved down slightly to 4.38%, and labor market utilization improved in December. However, job growth remains downbeat and narrowly concentrated in healthcare. Excluding healthcare, private payrolls have contracted over the past eight months.

The Commerce Department reported that the current account (trade) deficit declined by 9.2% to $226.4 billion in the most recent quarter. Evidence suggests that most tariff costs are being absorbed by both foreign exporters and domestic importers through lower profit margins. Joanne Hsu, of Fitch Ratings, recently noted that, “Tariff passthrough to consumers has been much milder than anticipated.”

Consumer activity has continued at a relatively strong pace into the new year, as activity among lower-income consumers improved. The contrast between this strength and continued negative consumer sentiment, which remains nearly 25% below where it was a year ago, is notable. We note that the CPI’s current level is below that reached at the start of all six prior recessions since its inception.

FIXED INCOME

Over the last 12 months, core inflation grew at a rate of 2.65% — near the Federal Reserve Board’s median forecast of 2.5%. Year-ahead consumer inflation expectations measured by the University of Michigan held steady in January at 4.2%.

The 10-year U.S Treasury yield was 3.65% on the eve of the first rate cut in late 2024. Today, the yield reached 4.3%. One reason that longer term bond yields have remained stubbornly elevated is that the fiscal deficit remains stubbornly large.

The waning impact of tariffs (for example, core goods inflation showed an annualized -0.03% in December) and continued shelter disinflation could push U.S. inflation lower later this year. Annual apartment rent growth of -1.3% in December and a rental vacancy rate of 7.3% have dampened future expectations of shelter inflation.

A weak dollar and strong gold have kept the Fed on hold, but we see an increasing likelihood that the Fed will implement additional easing later in 2026. Therefore, we are presently lengthening our average duration in fixed income.

EQUITIES

As the new year turned, so too did more U.S. equity market investors also seem to turn their focus towards value from growth. For the first time in many quarters, the Dow Jones Industrial Average significantly outperformed both the more growth-oriented S&P 500 and the Nasdaq indices. Much of this attraction can be attributed to the relative value that the Dow Jones constituents offered, but also to concern surrounding the extended valuations of some AI-related equities. To this writing, the trend has continued into January.

Our focus will be on those companies that can most effectively incorporate AI’s productive potential across diverse industries, offering superior long-term opportunities. Strong markets in 2025 remind us that economic patterns and cycles have natural ebbs and flows, and that each year brings the potential for change. While the path forward may include moments that test our endurance, it also rewards patience, resilience, and long-term perspective.