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Good morning. The US oil majors have given up most of the gains they enjoyed after Nicolás Maduro’s extradition. Refiners such as Valero and Phillips 66, on the other hand, have held on to their gains:

You can find out why this makes sense by listening to the latest edition of the Unhedged podcast, here or wherever you pick up your pods. If you know what happens next in Venezuela, by all means, let me know: unhedged@ft.com.

2026 predictions, part two

Part one of Unhedged’s 2026 predictions can be summed up like this: the economy is fine; while artificial intelligence euphoria will cool, the risk asset bubble is unlikely to pop; and the biggest potential spoiler is reaccelerating inflation. In part two, I will try to extend and specify this general picture. I will do this by asking and answering two more questions, one about the Federal Reserve and one about stocks’ sector performance.

Will the fed funds rate end the year below 3 per cent? No. Yesterday I pointed out that despite weak job creation and a slowly rising unemployment rate, the economy looks fine. GDP growth, consumption, profits, productivity and business investment are all trending in the right direction; corporate and household balance sheets are strong. There are important weak spots (housing, manufacturing) but fiscal stimulus from the One Big Beautiful Bill is on the way. So my view is that when the relationship between growth and employment normalises, it will normalise by the job market improving, not by output slowing. That, and above-target inflation, will limit the Fed to, at most, two more rate cuts.

Three per cent is about what the market expects, as the chart above shows. But that does not make this an easy call. Of course, my prediction of a stabilising job market could turn out to be wrong; if the unemployment rate moves from the current 4.6 per cent to, say, 5 per cent, a demand collapse and recession beckons (unemployment rises “gradually, then suddenly” in most cases). And there is also the politics: Donald Trump is set to appoint a new Fed chair this spring, and he has been emphatic that the key qualification for the job is agreeing that rates are way too high. Joseph Wang of Monetary Macro, aka The Fed Guy, thinks markets are underpricing the effect this will have:

The market appears to anchor itself to the current [Federal Open Market Committee’s] median long-run neutral rate of 3 per cent, even as the Fed is on the cusp of big changes…

Governor [Stephen] Miran, who is also a senior economic adviser to Trump, has laid out a case for a neutral rate that is 2.5 to 2 per cent. That is a level that most current FOMC members would consider modestly accommodative, which is an acceptable stance when the unemployment rate is trending higher and inflation is dismissed as transitory. A basic acknowledgment of political realities implies an adjustment to the Fed’s perceived reaction function. That suggests a trough that is below 3 per cent, and reasonably around 2.5 per cent.

I’m betting Wang is wrong, for four reasons. The first, obviously, is that I anticipate a solid economy next year. The second is that I think we are in an asset bubble, and I assume a majority of the open market committee agree with this, or at least suspect it. They are not honouring the employment side of their mandate if they inflate the bubble further, it bursts, and a recession follows. Third, I’m guessing that having a dovish chair is no more important than just having one more dovish committee member. That is, the new Fed chair will simply be outvoted if they should join the ultra-dovish Miran camp (even as mighty a Fed chair as Paul Volcker was, on occasion, outvoted).

As a peripheral, speculative point, I think once someone is appointed chair, they are out of the president’s reach. A market rebellion will stop Trump from removing a new chair who proves disobedient. The president may not get the patsy he expects.

Will cyclical, high-volatility sectors or defensive, low-volatility sectors perform better in 2026? Cyclicals. The economy is strong, with fiscal stimulus coming and the AI investment boom in full swing. Rates are going to fall, if only a bit. Scott Chronert, equity strategist at Citigroup, told me: “Soft landing + further Fed rate cuts make a good set up for cyclicals, such as banks, materials, cap goods . . . If you then add in the potential for further fiscal stimulus via tax reform and other administration efforts to boost the economy headed into next year’s midterms, these sectors are a natural rotation play.”

What is more, as Kevin Gordon of Chartles Schwab pointed out to me, the cyclicals may also benefit from “valuation fatigue” among growth-oriented, bullish investors — tech has just become too expensive. Cyclicals are a natural next trade.

Investors are starting to make the move. In the past month, the best performing sectors of the S&P 500 were materials, industrials and financials.

How could this be wrong? Patrick Kaser of Brandywine Global is keen on safe, low-vol sectors such as healthcare, staples and utilities. He notes these three sectors are trading at a big discount to the market and usually low-volatility stocks receive a premium. Meanwhile, the cyclical sectors are expensive. How does this pattern reverse? Kaser agrees with me that the economic set-up for 2026 is strong. But at some point, he says, the market will look forward into 2027 or 2028, and realise that the AI investment bonanza is going to cool and the market is at “at the mother of all peaks”. At that point, the hated low-vol sectors will start looking good.

Kaser has a point. Think, for example, of Caterpillar, an industrial stock that is up 70 per cent over the past year and 220 per cent over the past five, almost entirely on the back of power generator sales to data centres, while its core construction and mining businesses are sagging. What I’m betting is that non-AI investment picks up in 2026. But Kaser’s vision is, nonetheless, disturbingly plausible.

One good read

The big one

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