Prospects for 2026: “Goldilocks” Performance, but Risks Linger

In a new report from Citi Research, Chief Economist Nathan Sheets and a team of analysts and economists consider the impressive ongoing resilience of the global economy, which has shaken off prevailing challenges for four years running to keep growing at around a 3% trend. We expect global growth to remain on a broadly similar track for the next two years, with the economy expanding 2.7% in 2026 and 2.8% in 2027. Tariff pressures will take a further bite out of growth, but the overall effects look manageable. Despite this Goldilocks performance, however, fiscal risks remain part of the picture and must be weighed in looking ahead.

In reviewing global growth’s solid if not spectacular pace over recent years, we have a candid admission: We’ve consistently underestimated the resilience of the global economy. Even looking back, there were good reasons to expect an appreciable slowdown in growth, but the supply side of the economy has shown flexibility and a capacity to respond rapidly and smoothly to shocks, even sizable ones, while global labor markets have remained firm, supporting consumer spending.

In looking at the next two years’ growth, we see 2026 performances picking up a bit in South Korea, Australia, Sweden and Poland; rising but remaining subdued in Germany and Mexico; and yielding somewhat softer outcomes in India, China, Singapore, Spain and Brazil. In aggregate, we expect a modest easing in growth in developed markets from 1.7% to 1.6%, and a slowdown from 4.2% to 4.0% in emerging markets.

Global purchasing managers’ indexes (PMIs) have shown themselves to be useful windows into economic performance of late, highlighting the sustained strength of the services sector relative to manufacturing: Over the last few years, services-intensive economies such as the U.S. and Spain have outperformed manufacturing-intensive ones such as Germany.
We also note two observations about PMIs’ more recent evolution. First, they’ve shown little imprint from the Trump administration’s tariffs, with their 2025 performance continuing along a trajectory broadly similar to that of the previous few years. Second, recent readings for both services and manufacturing have been in the upper part of recent years’ range. This signals that the global economy is on solid footing as it enters 2026.

The aggregate global inflation story has also remained uneventful. Over the past year, headline inflation has hovered at or near 2%, with core inflation running a notch higher at a still subdued 2.5% as global services inflation has declined only gradually. 

The more interesting story, to us, is the divergence between the U.S. and China. The U.S. continues to struggle with above-target inflation, reflecting both the signature of U.S. tariffs and sticky non-shelter services inflation. The slow descent of inflation has been a factor constraining the Federal Reserve’s rate-cutting pace. China, meanwhile, has struggled with persistently low inflation, marked by the demand side of its economy struggling to keep up with rapid expansion for the supply side.

Taken together, the combination of resilient global growth and restrained inflation points to “Goldilocks” performance. “Optimism” may be too strong a word, but we at least feel a degree of comfort about the 2026 outlook, a sharp contrast to our more dour assessments from recent years.

We are fully aware that the global economy faces continued challenges, with five in particular requiring close scrutiny in 2026. But none of these challenges is more imminent or severe than ones the global economy has faced in recent years and successfully shaken off. 

Tariffs and their impacts

We were surprised by the aggressiveness of the Trump administration’s tariff campaign this year: At present, the overall U.S. tariff rate is running near 15%, up from 2.5% at the beginning of this administration. U.S. tariffs are now at their highest level in more than 80 years, and we’re learning in real time how modern economies adjust to abrupt changes in goods prices.

A note before discussing the economics: Tariffs’ trajectory through next year remains an open issue, with further tariffs still potentially in the offing and President Trump clearly seeing tariffs as one of his signature policy initiatives. That argues for high tariffs likely remaining a fact of life. But at the same time, there are increasing political pressures around “affordability” with midterm elections in November, and such pressures could lead to further carve-outs. There’s also the possibility that the Supreme Court will reject tariffs imposed using the International Emergency Economic Powers Act (IEEPA), which would create an opportunity for the White House to soften the blow on products sensitive for consumers.

While U.S. tariffs have been larger than we expected a year ago, their economic effects have been relatively contained. A key reason is front-loaded U.S. spending, as households and firms sought to get ahead of the tariffs’ imposition. This front-loading has supported U.S. imports and global exports through much of the year. August U.S. trade data suggested we were finally starting to see some payback for this spending; we anticipate further payback is likely in the months ahead, generating some headwinds for global trade.

As a related point, the tariffs have triggered a marked rebalancing of U.S. trade, with the economies of the U.S. and China clearly decoupling. As China has lost U.S. market share, Taiwan, Vietnam, Mexico and Thailand have been winners, with the latter three countries looking to be picking up share at China’s expense. (Granted, some of these gains likely reflect China re-exporting goods through these countries.)

Mexico’s gains highlight its geographical proximity to the U.S. and favorable access to the U.S. market under the United States-Mexico-Canada Agreement (USMCA). As such, Mexico looks well positioned to compete against China, while Canada has seen a significant decline in its share of U.S. imports as U.S. firms have found ways to move production to the U.S. side of the border. We see renegotiation of USMCA as an issue of increasing focus in 2026. Our sense is that the deal will likely be renewed, though Mexico enters such negotiations with more advantages than Canada has.

Despite sharply reduced access to the U.S. market, China’s overall exports have been surprisingly strong in 2025, with lost U.S. share more than offset by stronger exports to ASEAN, the European Union and elsewhere. The key question is how sustainable this reorientation will be, with one narrative that China is successfully diversifying its export markets, including increased South-South trade and less concentrated supply chains. We note October’s fall-off in Chinese exports; a major question for 2026 is whether Chinese exports can maintain their robust growth performance.

Tariffs are leaving a mark on global inflation, pushing up goods inflation in the U.S. while performance is roughly unchanged elsewhere. That’s consistent with our view that the tariffs act as an adverse supply shock for the U.S. economy, raising inflation, while serving as a negative demand shock elsewhere, restraining inflation.

Given the size of the tariffs, the pass-through to U.S. inflation has been slower and less pronounced than we’d expected: We estimate that well under half of the tariffs have been passed through to consumers, with much of the burden absorbed by U.S. firms. While large U.S. corporates haven’t signaled inordinate pressure on margins, we think tensions have been greater for small and medium-size firms, and will be watching closely for increased signs of tariff pass-through to consumer prices, with this issue especially front and center during 2026’s first quarter.

We’d sum up our analysis with three broad conclusions. First, the tariffs have had notable effects on the contours of global trade, inflation and spending, with these effects likely to keep being felt through at least the first part of next year. Second, while these effects have been significant, they’ve also been less severe than we’d anticipated. Third, given what we’ve seen, we doubt the tariffs will at this stage deal a disruptive blow to global growth or inflation, and we judge recession risk as low.

Five risks to monitor in 2026

While we’ve been struck by the global economy’s resilience, that economy faces potentially key challenges and risks for 2026, five of which we’ll be monitoring closely.

The first risk is a larger than anticipated bite from tariffs. Despite 2025’s resilience, it’s possible that more severe tariff effects are still in the pipeline. Next year could bring a sharper and more sustained softening in U.S. spending as front-loading is paid back. This scenario could also involve more pronounced inflation pass-through as firms seek to restore their margins, complicating the Fed’s efforts to ease monetary policy.

Second, we’ll be watching for a sharp deterioration in the U.S. labor market. Historically when the labor market begins to soften it tends to keep doing so, with further softening often proving abrupt. Still, our expectation is that any further deterioration will likely be gradual. 

Third, we must keep an eye on downside risks to AI investments and valuations. The AI sector has been an important driver of global economic activity in 2025, especially in the U.S. and Asia. But more recently we’ve seen market concerns about sustainability. We remain confident in the underlying technology and expect it to bring gains in the years ahead, but the path to adoption is unlikely to be smooth; while a meaningful retrenchment in the AI sector isn’t our expectation for 2026, we see it as an important risk.

Fourth, we note weaker than expected private spending in China. Our baseline forecast is for China’s economy to continue to grow at nearly a 5% clip in 2026, but the outlook for private demand is a notable concern. In particular, the growth of Chinese fixed-asset investment has turned down sharply and consumer sentiment has shown sustained weakness. We assume the authorities will provide stimulus as needed, but the deeper challenge is jump-starting a lagging consumer sector.

Finally, we note high public-debt levels in many countries. A broad set of countries are pushing the traditional boundaries of debt sustainability: Among developed markets, Japan, Italy, the U.S., France, Canada, the UK and Spain all have public debt levels at or exceeding 100% of GDP, with debt levels in China, Brazil, India and South Africa a notch lower but still exceptionally high by conventional metrics for emerging markets. Elevated debt levels and the associated deficits may lead to a broad set of challenges and uncertainties, weighing on confidence and private spending even as fiscal space is constrained and governments limited in their ability to respond aggressively to adverse developments. So far major countries have generally escaped the most severe manifestations of these challenges, but they remain vulnerable.