Top of the Morning: CIO Strategy Snapshot - Starting with a bang

Hi everyone, Siobhan Chapman here and welcome to Top of the Morning on the UBS Market Moves podcast channel. It was quite a first week of 2026. Every day brought important news and economic data or an unexpected policy announcement, whether on defense contractors, investors buying houses, buying mortgage-backed securities or credit card interest rates.

But through it all, financial markets globally have performed well to start off the year. Joining us to discuss it all for the CIO Strategy Snapshot is Jason Draho, head of Asset Allocation Americas with the UBS Chief Investment Office. Jason, good morning and welcome back.

Good morning, Siobhan. Happy New Year. I think it's probably the last day I can say that.

Happy New Year, Jason. So let's start with the market performance to begin 2026. It is strong, but exactly how would you characterize it?

Well, if you look across all asset classes, equities, bonds, commodities, even currencies, what I'd say is that the market performance year to date implies expectations for cyclical growth acceleration in the U.S. and globally, yet with the sort of disinflation trends still in place, like a relatively benign borderline even kind of Goldilocks kind of scenario. So if we look at the equity market performance kind of across the world, different equity markets, they're almost all uniformly positive, but there's definitely a tilt towards more economically sensitive market segments leading the way. For example, in the U.S., the S&P 500 is up 1.8 percent as of Friday's close, whereas the Russell small cap index, the Russell 2000, is up 5.75 percent.

You can also see it in sector performance. The more cyclically oriented sectors, materials, energy, industrials, financials, all leading the way versus defensives kind of being the relative laggards. Outside of the U.S., developed market equities up 2 percent, emerging markets up 3.5 percent.

If you look at interest rates, the 10-year yield as of Friday close basically hadn't changed at all year to date. The two-year yield had gone up a little bit on sort of rate cut expectations being pushed out. But industrial metals, again, something that's sensitive to the overall global economy, up 4 percent, same with oil, around 4 percent.

It's also up 4 percent, although you could think of that as probably perhaps more in response to various geopolitical events that happened since the start of the year. That said, if you kind of look at, again, the market pricing, there's not a lot of indications that investors are too concerned about politics or U.S. domestic policy, geopolitics. There was no real flight to safety bid.

The treasury yield didn't decline as a result of developments, for example, in Venezuela. And then the VIX volatility index at 14.5, it's near its one-year low, and it's not really that far above its five-year low of 12.5. So the market implied sort of fear gauge relatively contained, yet sort of economic policy uncertainty index is still well above its average from, say, 2022 to 2024, off its peak of last year, but still suggesting a lot of policy uncertainty.

So the all-told, what is the takeaway in terms of how to characterize the market performance so far this year? I'd say investors are breaking kind of a running hot narrative of growth accelerating and they're brushing off thus far geopolitical and other policy risks. So Jason, is this market pricing for silico growth acceleration consistent with economic data and the outlook?

I'd say yes, but with a caveat that, you know, the data remains noisy, it's still somewhat incomplete. We're trying to get through the implications of like a March head down where a lot of data was delayed or, you know, kind of estimated. And then, you know, the December payrolls report that we got on Friday sort of consists with that.

You know, depending on your perspective or how you want to look at it, you could sort of have a relatively positive rate or negative rate. On the one hand, the unemployment rate fell to 4.4 percent. That's for December.

The November number had been revised down, so it went from like a 4.6 on a rounded basis to 4.5, and now it's down to 4.4. Average hourly earnings growth is relatively strong. The private sector payrolls growth, you know, they came in at just 37,000, and the three months that are moving average is down to 29,000.

That's kind of below what, you know, we'd expect to be sort of as a break-even level like given the national internal labor market, you know, you need to probably have somewhere in the neighborhood of 60,000, 80,000 new jobs created a month, otherwise you risk having the unemployment rate go higher. So that's, you know, again, some signs are okay, some signs are a little bit more kind of concerning. But if we kind of look at the totality of labor market data that's come out, you know, last week and really over the last month, the story that tells is that the labor market softened and became clearly evident sort of starting late in the summer into the fall.

That sort of softening has ended. We're seeing sort of stabilization has begun. Now I think what we'd expect is sort of modest growth acceleration in the first half of this year, reflective of overall kind of growth conditions, and we do expect growth, you know, to accelerate especially in the first half of the year due to easier financial conditions.

There is overall some less policy uncertainty, particularly regarding, you know, tariffs. And the biggest driver, though, is fiscal stimulus, you know, the benefits of the one big bill, you know, start to materialize relatively early on, beginning with, you know, larger tax refunds. So definitely expect higher growth, and then the labor market should kind of, you know, benefit with that.

And that's what the markets are sort of pricing in. One thing I just want to, you know, mention is for those who kind of follow this closely, the Atlanta Fed GDP Nowcast measure for GDP growth in the fourth quarter as a priority it's over 5%. And if you look at it, like, well, what are we talking about growth accelerating, it was already really strong in the fourth quarter.

That number that's going to probably get widely cited and, you know, could be, you know, over the coming weeks is that it is being distorted by very narrow trade deficits. In October there was a steep drop in sort of pharmaceutical inputs, and there's also a surge in gold exports that caused the overall trade deficit to narrow. The way the GDP is calculated is that a smaller trade deficit to a lower negative exports it actually implies a boost to U.S.

GDP growth. And that alone caused the tracking estimate for fourth quarter GDP to go from around 2.8% to around 5.2%, which is clearly not a true reflection of the underlying state of the economy. You know, if we strip that out, you know, we expect actually the private sector after all this sort of, you know, trade noise to soften in the fourth quarter and then reaccelerate in the first half of this year.

So going back to the question, you know, is the market pricing for kind of growth acceleration consistent with the data? I'd say given sort of what we've seen, the stabilization of where it's likely to go, it is sort of consistent with that trend for the economy. What does this mean for Fed rate cuts?

Well, it's interesting if you look at the market pricing for a rate cut in March, after the payrolls data came out, the market pricing went from about a 50% chance down to about a 30% chance. And at the end of January, the Fed is meeting, and now that's, you know, getting very close to zero. So it's very unlikely that the Fed would cut then.

The way you interpret this is that the markets and investors put a lot more emphasis on the unemployment rate going lower rather than job growth being relatively weak. You know, for the time being, we are sticking with the idea that the Fed's going to cut, you know, in March, but it's getting closer to a toss-up. You know, I think a critical assumption that we're relying on is that the actual job growth, like the true job growth in the economy, is actually less than these official numbers state.

So I mentioned the three-month moving average of private sector payroll growth is 29,000. We know for the past few years that ultimately these payroll numbers are being revised down, you know, upwards of like 50,000 to 60,000 a month. If you assume this will continue or could continue, and let's take it down by even 40,000, that means the last three months we're annualizing or averaging, you know, a negative job growth in the private sector.

And that would have the Fed concerned that this is sort of, you know, not unsustainable and that pushed them towards cutting. But between now and March, there's two more months of payroll data, three more months of inflation data, plus other data, so a lot can certainly change between, you know, now and then. And the one thing that I, you know, do want to comment on also is, you know, on Sunday night it was reported that the Department of Justice has opened a criminal investigation to Fed Chair, you know, Jay Powell, who quickly issued a kind of a pretty rare and sort of, you know, somewhat, you know, defiant response, you know, as a result of that.

You know, this just kind of adds questions or fuels kind of concerns in the marketplace about, you know, kind of Fed independence and, you know, will they be, you know, influenced in some way in terms of setting interest rate policy. But that is how this investigation will play out. I don't want to speculate on that.

Even regarding kind of Fed independence, you know, that's, you know, us more kind of speculation at this point in time. What we sort of know with a little more certainty is that this complicates sort of perhaps the timeline for announcing a new Fed chair and having that person, you know, in place. Just last week there was kind of reports that President Trump would make the announcement either this week or next week.

That is still possible. But, you know, shortly after the news broke regarding the DOJ investigation, Tom Tillis, who's a Republican senator from North Carolina, said that he would oppose any nominee to the Fed board until this legal matter is fully resolved. Like, that's a quote.

This matters because in the Senate Banking Committee, the Republicans have a 13 to 11 advantage. Tillis is on that committee. If he were to vote with Democrats, assuming the Democrats are aligned, it'd be a split vote 12 to 12.

And if it's 12 to 12, it's a tie vote. The candidate fails. So it wouldn't even get out of the committee.

So this creates some pressure to then nominate a person that the committee and now Tillis could sort of support. And if he truly is concerned about the legal clarity, that could sort of have things kind of drag on. We know that later this month on, I think it's due January 21st, the Supreme Court is set to hear the case regarding current Fed Governor Lisa Cook regarding issues with mortgage applications.

They probably won't rule later this spring. But whether she is forced to step down, whether Jay Powell, whose term as Fed Chair expires in mid-May, he could stay on as a board member. The typical pattern is that the retiring Fed Chair steps down.

You need also, you need a seat for someone to take the place. Stephen Myron, who was nominated as a temporary candidate, could step down as term expires. This is also uncertain.

So I think that's the one thing we can say, given the latest news, is that the timing of when this could, you know, a nominee for the new Fed Chair could be announced, but also approved, that maybe gets kind of pushed out and adds some uncertainty to the marketplace overall. There was a flurry of potential policy announcements from the Trump administration last week. How does any of it impact the investment outlook?

Well, if we go through, you know, last week, what happened over the course of six days. So if you got the weekend, you know, began with the removal of Venezuelan President Maduro. From the market's perspective, the prospect of increased oil supply, you know, President Trump talked about constraining what defense companies and contractors can pay out to shareholders and dividends and share buybacks.

There's also a proposal to increase defense spending by 50 percent. There was talk of restricting what institutional investors can buy in terms of homes. There was a call for a 10 percent cap on credit card interest rates issued by banks.

There was a call for Fannie and Freddie, your two kind of quasi-government agencies, to potentially buy up to $200 billion of agency mortgage-backed securities. This is all within the first week. And what we didn't get last week, but we might get this week, is a Supreme Court decision on the IEPA tariffs under legality, which, of course, would add sort of just more uncertainty to the marketplace.

Without comment on each individual case and, you know, the likelihood of how things or policy of how things could play out, to me, I'd kind of emphasize three main investment takeaways from all these developments. First is that, while there's a lot of noise or a lot of news, I think none of these policies would materially change the 2026 macroeconomic overall. They're more like tweaks at the margin compared to, you know, the policy developments in 2025, which obviously included, you know, ramping up tariffs, you know, so the effective tariff rate went from like 2.5 percent to closer to 15 percent, the passage of the one big beautiful bill, and a significant crackdown on immigration.

So those are bigger things that would impact the economy versus, I think, this year, all that what we've talked about are all, everything that I listed is much more tweaks at the margin. A second sort of, you know, point is that the common trade amongst all these policies that were, or desired policies that were announced last week, you know, is there a time to address kind of affordability concerns, and, you know, that's certainly a clear policy focus for the administration going into the midterms, and each of those policy measures in some way tries to deal with that, with getting your rates lower, you know, less demand for houses, things of that sort. And then the third sort of investment takeaway of these policies is that, of all of them, I think what might be the most relevant for the markets overall is the potential MPS purchases, and this is less about the actual purchases themselves in terms of how much even $200 billion of MPS purchase could move the market, it's more about the signal that it sends regarding the administration's desire for lower interest rates, you know, and if, in two different And it's not just the MPS purchases, the Treasury could alter, you know, its supply, shift more towards T-bills rather than, like, longer maturity bonds, by doing that effectively you have less supply for long bonds, given a certain amount of demand, that pushes up the price and therefore lowers yields.

So there's multiple things that perhaps the administration could do that, you know, could lift, you know, could try and get interest rates to go lower. If you do succeed in that, then we'll have to tailwind for all risk assets. Now, how effective these policies will be in achieving this kind of affordability goal, that's debatable.

You know, if you lower rates, that's going to have more of an impact, though, because in supporting demand and inducing more supply, I think that, you know, kind of is one of the reasons why this sort of running hot narrative is in place, that, you know, you're going to do things to sort of boost, ultimately, your demand, more so than supply, and that's necessarily, you know, deal with affordability issues directly. And ultimately, if that's the policy approach for this year, it's something that investors are going to have to keep in mind that you have an administration that is supportive of this kind of running hot narrative, you know, one way or another. So we are coming to the end of our conversation, Jason.

After a furious first week of news, what's your bottom line takeaway for the 2026 outlook? Well, I think, you know, the strong start for risk assets suggests that there's much more sort of noise and signal in the news from last week, and that investors are increasingly confident about this kind of cyclical growth acceleration in what's called a running hot economy. And if I go through the data in more detail, even though we've covered here or all the different policy, you know, announcements last week, what could be a moment?

What does it mean? I think it also kind of supports that general view. That's why, you know, we came into the year relatively constructive for the economy, expected growth to kind of pick up, macro conditions to be supportive for risk assets, and that's what we've seen play out thus far this year.

And so nothing that was announced last week necessarily alters that. You know, policies, as I mentioned, to try and get interest rates lower, maybe motivated by affordability concerns. But in some way, I think investors are probably more likely to be the primary beneficiary, especially if the economy accelerates.

And so in that environment, you want to think about our key messages and positioning. That's good for equities. It's a pullback to the market.

We think our opportunities to kind of add exposure, you know, add in also exposure and maybe a little more cyclical parts of the market. You know, the movement of rates last week is, you know, relatively flat overall with the front of the curve moving up. We think it's going to probably be relatively, you know, narrow range bound fixed income markets to sort of be selective there, especially in the riskier parts of the corporate credit space.

It probably has to be relatively nimble within fixed income overall. You know, we like commodities and gold within commodities and the performance already this year to date. And as of, you know, Monday morning, with gold up another roughly 2%, that's consistent with this idea that gold is a store value that investors are looking for.

And what can you be kind of supportive concerns about, you know, sort of monetary policy, inflation, running hot, all that is kind of good for gold. And it's also good for suppliers. So some of the key investment themes we had coming to this year have played already the first 12 days of the year and the developments in policy, economic data are supportive of that.

OK, perfect. Jason, thank you so much for joining us. You're welcome.

Have a great week. Have a great week, Jason. Again, today we have been joined by Jason Draho for Top of the Morning on the UBS Market News podcast channel.

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