Our 2026 macro outlook for public and Taft-Hartley defined benefit plans

The US economy continued to grow during the second half of 2025, supported in part by strong AI-related capital spending. The pace of economic growth slowed, however.

The six-week government shutdown restrained growth, and although consumer spending remained solid in aggregate, it split along income lines: Higher-income households generally fared well, while lower-income households struggled.

The labor market softened, with unemployment rising from 4.1% in June to 4.4% in September.¹ Meanwhile, the interruption in government data caused by the shutdown made it difficult to gauge the extent to which the job market was weakening. The Federal Reserve attempted to support employment by twice lowering its target short-term interest rate by 25 basis points in September and December. A pickup in inflation complicated the Fed’s decision-making, however. Inflation rose to 2.7% for the 12 months through December—up from an annual rate of 2.3% in April.²

Equity markets bounced back from the downturn they suffered in early spring, with the S&P 500 gaining 18% for the full year. The MSCI EAFE Index of international stocks rose 31% over the same period, as attractive valuations supported price appreciation and the US dollar weakened. In fixed income, the yield curve steepened. The yield on the 30-year Treasury bond ended December at 4.8%, higher than it had been one year earlier, while the two-year Treasury note yield fell from above 4% to near 3.5%.

These conditions were favorable for public and Taft-Hartley plans, which benefited from strong returns by growth assets as well as fixed income yields near cyclical highs. Funded ratios generally improved, with the Milliman Public Pension Funding Index rising to 86.3% by October.

We believe the macroeconomic outlook for 2026 is positive for pension plans, on balance. State Street Investment Management has increased our estimate for 2025 US GDP growth from 1.7% to near 2%, and we project GDP growth to increase to 2.4% in 2026.

Several tailwinds could support continued economic growth. The recently enacted tax and spending law known as the One Big Beautiful Bill Act provides fiscal stimulus, and we believe it may lead to tax refunds that help bolster consumer spending. (In fact, the US Treasury estimates the law will yield $100 billion in total tax refunds in 2026.)³ We expect the Fed’s recent rate cuts to make their way through the economy over the coming year, and we think the Fed is likely to cut interest rates two or three more times. Meanwhile, the AI-fueled boom in capital expenditures should continue to contribute to economic growth. We have some concerns about the labor market and consumer spending, but we believe in aggregate these developments should help the economy strengthen.

We do not expect inflation to accelerate, despite tariff-driven price pressures on certain goods. We think the Consumer Price Index may anchor in a range of 2.7%–3.0%, as declines in some areas, notably shelter costs, help offset tariffs’ inflationary impacts.
This backdrop gives us a constructive outlook for risk assets. A generally positive macro environment may support corporate profits and help allay investors’ concerns about inflation and growth, laying the groundwork for gains in the equity market.

That said, there are a number of risks to that outlook, starting with high equity valuations. Some investors argue that US stocks are experiencing an AI-driven bubble akin to the dot-com frenzy of the late 1990s. We don’t believe that is the case.

Past investment bubbles have been characterized by poor business fundamentals, including debt-fueled spending on economically dubious investments. By contrast, fundamentals today look healthy. We don’t see excess leverage in the system; much of the money being pledged for AI research and development is coming out of free cash flow (though some companies have begun issuing debt to fund AI investments); and the companies that are responsible for most of it have strong earnings. Although we acknowledge that valuations are high, elevated valuations have been the norm during periods around technological inflection points, and in those situations, high valuations have tended to persist for extended periods of time.

Uncertainty around the direction of monetary policy presents another key risk for pension plans. It is impossible to say with certainty whether or how much interest rates may decline. Significantly lower discount rates could increase plans’ liabilities, exerting downward pressure on their funded ratios.

Geopolitics and government policy changes also have the potential to fuel volatility in the financial markets. In recent months, the Trump administration’s shifting policy goals and approaches have contributed to an unpredictable market environment.

However, today’s high level of geopolitical risks doesn’t guarantee an uptick in volatility. We think many consequential policy areas for the markets have already been addressed. The passage of the OBBB Act provided clarity on taxation and stimulus, and the major tariff announcements of 2025 are largely behind us. That said, the Trump administration recently considered imposing tariffs on several European countries that oppose the administration’s plans for Greenland.

Implications for public and multiemployer defined benefit plans

Pension plans have benefited from an exceptionally positive environment in recent years. Equities have exceeded expectations for much of the past half-decade, producing total returns of 96% during the five years through December 2025.⁴ At the same time, relatively high interest rates have generally kept discount rates for public pension plans in the range of 6.5%–7.5%,⁵ helping restrain liabilities.

Although we have a constructive macro outlook for growth assets in 2026, we think public and Taft-Hartley plans should prepare for the possibility that conditions may not remain quite as favorable as they have been recently. High valuations in both public and private equity could cause growth assets to produce more modest returns, even as normalizing monetary policy may reduce discount rates. In addition, we think we could face renewed interest rate volatility, given the United States government’s growing indebtedness and the range of macro risks in the current environment.

Public and multiemployer plans looking to build on recent years’ funding gains will need to continue seeking asset growth. At the same time, they will need strategies that can manage the variety of risks presented by today’s macro environment. Plans may respond to this landscape by looking to capitalize further on private market investments that offer potential growth premiums, yield advantages, and low correlations to public assets. In addition, real assets and precious metals such as gold can deliver benefits such as diversification.

Greater use of private assets demands sophisticated approaches to liquidity management. Public and Taft-Hartley plans may want to explore tools and strategies to help ensure that they retain access to the liquidity they need while pursuing resilient growth.

For more information about State Street Investment Management’s macro outlook, liquidity management for public and Taft-Hartley plans, or other defined benefit-related topics, please contact us.