- Sharp sell-off in crypto market suggests a risk-off mood going into the new year.
- Concerns about AI-related overvaluation of the stock market will persist.
- Jobs data looks somewhat unhealthy and have a late-cycle feel.
- Financial sector stability issues could return in 2026.
- Inflation could nudge up well past 3% and spoil the party in 2026.
Commentary: Risks lurking underneath
On the surface, the US economy has entered the final leg of 2025 with a great deal of strength. As per Atlanta Fed’s Nowcasting analysis, economic growth momentum presently is the highest seen this year. Durable goods orders, manufacturing PMI, retail sales, non-residential investment, and public spending trends point to above-trend GDP growth in 3Q and perhaps also in 4Q. Our 1.9% GDP growth forecast for 2025 is characterised by substantial upside risk.
Beyond real economic activity, the signals from the financial markets are also largely bullish. Some concerns about an AI-bubble notwithstanding, equity markets are on course to the end the year with substantial gains. Credit markets are enjoying record narrow spreads, interest rates on public debt are easing, and currency markets are stable. The Fed may not be ultra dovish (yet), but the market is quite sure that the path ahead features lower rates and ample liquidity.
But is the outlook paved with nothing but comfort? We are picking up a series of clues that point toward potential headaches down the road. Consider the following:
Crypto sell-off: Despite the headlines they create, digital assets, particularly crypto currencies, don’t make or break the US economy. Yet, over the past decade, they have captured the imagination of investors, retail and institutional. Recent price actions, with Bitcoin down 27% from its highs, suggest major risk-off sentiments. This could be driven by regulatory uncertainty, some major crypto-related law enforcement action, and marginally tighter liquidity. But regardless of the driver of the price decline, the development itself is notable as it displays a degree of exhaustion in the speculative asset markets.
Concerns about the disproportionate share of US equity market performance being driven by the AI boom will persist in the coming months. With cyclically adjusted price-earnings ratio of the S&P500 at an all-time high, and most of recent gains being driven by a handful of hyper-scalers, a correction down the road won’t be shocking, but would have sizeable negative implications for sentiment and investment.
Labour market developments could pose risks to the consumption outlook. This year’s jobs data looks unhealthy and has a late-cycle feel compared to that of the Biden era or even Trump 1.0. Goods sector job creation is in negative territory, while public sector jobs are few. Private sector job creation continues, but at a much weaker pace than trend.
Financial sector stability issues could return in 2026. Light-touch regulatory approach of the Trump administration on digital assets and broader financial intermediation could cause the market to turn jittery. Along the same vein, if the Fed’s independence looks to be more and more in jeopardy, a longstanding anchor of the financial sector could lose its footing.
Finally, inflation. Cost of living concerns dominated this year’s off-cycle elections, and they won’t fade, especially if the Fed ends up making an error by keeping policy too lose. From tariff passthrough to immigration tightening-led rise in the cost of workers in services and construction, inflation could nudge up well past 3% and spoil the party in 2026.
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