How likely is a recession in 2026?

Paul Danis
Head of Asset Allocation
RBC Brewin Dolphin

2025 was a strong year for investors across major markets. But it was also a year where talk of recession ramped up, prompting many of our clients to ask: What are the chances of recession in 2026?

Before addressing these concerns, let’s clarify what a recession entails. Technically, it’s defined as a significant, prolonged downturn in economic activity, usually measured by two consecutive quarters of negative gross domestic product (GDP) growth. Now, let’s explore the key questions shaping the recession outlook for 2026.

Why do recessions matter?

Recessions hit close to home. They often mean job losses and insecurity, weaker business growth, and a fall in stock values. For context, the S&P 500 equity index has declined by an average of 36% around the eight U.S. recessions that have occurred since 1970. With stakes this high, understanding the risks is important.

Where are we in the economic cycle at present?

An economic cycle describes the recurring pattern of GDP growth accelerating, slowing and contracting around a trend rate over time. We believe that most economies – including the UK and U.S. – are in the later stages of the economic cycle. This is because there’s limited spare capacity that can be employed to drive growth. For example, unemployment rates are close to what economists believe to be ‘full employment’ and labour force participation rates are probably not going to rise much further. Economies can continue to expand from ‘structural’ growth – namely labour force and productivity growth. But there doesn’t appear to be much scope for ‘cyclical’ growth.

What’s the outlook for structural economic growth?

In the U.S., the Trump administration’s immigration clampdown is holding back labour force growth. However, productivity gains from rising AI adoption could offset this.

The UK faces similar challenges, with slower immigration growth reducing labour force growth. AI adoption should support productivity, but there are uncertainties about how quickly and the magnitude of its impact. For instance, the Office for Budget Responsibility expects just a 0.2% annual productivity boost from AI over the next five years.

While there are moving parts, our sense is that for now, we won’t see much change in the potential growth rate of economies like the U.S. and UK over the next several years.

How are monetary and fiscal policies impacting the economy?

Falling interest rates tend to boost economic growth via multiple channels, not least by encouraging borrowing. Greater government deficit spending (lower tax and higher spending) can also boost growth, provided it doesn’t spark an overly sharp rise in interest rates (the 2022 Liz Truss mini-budget is an example of that backfiring).

Interest rates have fallen from recent highs in both the U.S. and UK, supporting economic growth. Our view is that long-term interest rates and bond yields are probably not going any lower in the U.S., but they have scope to decline a little further in the UK as inflation converges lower with most other developed economies.

On the fiscal front, the Republicans passed a large package of measures in mid-2025. This primarily extended expiring tax cuts and slashed Medicaid and other spending, limiting its growth impact.

In the UK, the Labour Party outlined an Autumn Budget that’s set to boost government spending over the next few years, funded by tax rises in later years. We don’t expect the measures to meaningfully change the trajectory of the UK economy, but the positive reaction to the Budget from the UK bond market (gilt yields fell) should provide some moderate support to growth.

What about the impact of tariffs?

Tariffs can provide short-term protection to certain domestic industries, potentially boosting output. However, these benefits come at a cost: higher prices for consumers and businesses, reduced competition, distorted global supply chains, and reduced economic efficiency. Elevated prices in the U.S. also reduce the extent to which the Federal Reserve can cut interest rates.

The impact of tariffs on global growth has been weaker than many economists feared, so far at least. This reflects President Trump’s softened stance and limited retaliation from U.S. trade partners. Nonetheless, the situation warrants close attention.

Are recent credit market wobbles cause for concern?

Commercial bank lending to what are called non-depository financial institutions (such as private credit funds) has surged over the past decade. It’s against this backdrop that the bankruptcies of auto parts supplier First Brands, and subprime auto lender Tricolour have spooked investors.

First Brands primarily relied on private debt markets to borrow, but banks including Jefferies and UBS built up large exposures to its invoice-linked financing. Following the news, Jamie Dimon warned that “when you see one cockroach, there are probably more”. Shortly afterwards, Andrew Bailey set off further alarm bells, drawing parallels between what was going on during the Global Financial Crisis of 2008. When the JP Morgan CEO and Bank of England governor make comments like these, we should take the risks seriously.

That said, there are several reasons to be cautiously optimistic that we aren’t on the cusp of a new credit crisis. Private sector balance sheets are healthy, banks are well capitalised, and lending standards remain prudent across most loan categories.

What sort of developments would concern you that recession risks were rising?

Recessions are driven by a contraction in consumer spending and/or business investment. Several developments could cause this to occur. A key risk is that inflation remains stubbornly high, which would limit the extent to which central banks are willing to cut interest rates, or worse, prompts them to raise rates anew.

There are signposts we monitor that have historically provided advance warnings of a recession:

• Credit spreads (the difference between corporate and government bond yields) often widen ahead of a recession, as traders become worried about rising default risk. While credit spreads are off their cycle lows, the widening has been minimal.
• Yield curve slopes (the difference between long-term and short-term government bond yields) usually narrow or flatten to signal rising risks. At present, yield curve slopes in most bond markets have widened/steepened, which is encouraging.
• AI-related investment has been a big driver of growth this cycle, but a slowdown would alter that trajectory – we’re monitoring this closely.  
• Economic feedback loop – normally, economic expectations drive the equity market. But the order can sometimes reverse. If stocks drop sharply (say, over valuation concerns), the resulting confidence and wealth effect (where investors consume more when asset prices rise and vice versa) could spark a recession.

So, are we going to get a recession in 2026?

Despite the lack of room for cyclical growth and the risks stemming from higher tariffs, we don’t see a recession in 2026 as a base case scenario. Here’s why:

• Inflation and interest rates have moved lower.
• Household and business balance sheets are in good shape, which isn’t often the case heading into a recession (2001 and 2007 are notable examples).
• Global excesses are manageable –while excesses (such as government debt) and imbalances do exist, they’re not too severe, in our view.
• AI investment stays robust – while there’s a risk of AI-related spending moderating, most of the companies doing all this investment report that it’s still not enough to keep up with demand.

What could cause you to be wrong?

Recessions are often driven by shocks, which are difficult to predict. To again use the U.S. as an example, five of the eight U.S. recessions since 1970 involved shocks (three oil shocks, a terrorist event, and a pandemic), which were hard to see coming.

This cycle, a similar shock, or a new one – whether an escalation of trade wars, a military war (such as China invading Taiwan), or an entirely new crisis – could spark a recession.

But shocks aren’t the only recession catalysts. For example, if inflation were to re-accelerate, forcing central banks to raise interest rates anew, that would raise recession risks. And while private sector balance sheets are in good shape, government balance sheets are stretched, implying less room for additional fiscal policy to support economic growth.

Finally, considering this outlook, how are you positioned?

Our view that the global economy continues to expand is consistent with corporate profits continuing to grow. In addition, the Federal Reserve and Bank of England are in rate cutting mode and we believe that AI is set to drive a significant productivity improvement. As such, our asset allocation guidance recommends a tactical overweight position to equities.

However, we acknowledge that risks to the equity outlook are elevated, not least because valuation multiples are extended, particularly in the U.S. As such, we only recommend a moderate overweight position in equities. We’ve partially hedged this equity exposure in our central investment construction guidance with:

• An overweight position in government bonds relative to riskier corporate bonds.
• A modest overweight position in gold, which could do well in recessionary environments that are associated with relatively strong inflation.

This balanced approach positions our portfolios to capitalise on upside while guarding against downside surprises.

Do you have questions about your investments? Don’t hesitate to reach out to your wealth manager – we’re always here to help.

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