Ten years from now, Jim Masturzo argues, investors will not remember 2025 for a crisis—but for something more subtle and arguably more consequential. It will be remembered as the year markets finally let go of the assumption that the ultra-low-rate, low-inflation, central-bank-backstopped world of the past quarter-century was coming back.
“As the clock struck midnight on the year, we can see that 2025 represented not an end but an inflection point,” Masturzo writes. “The era of ultra-low rates, central bank liquidity, and subdued inflation is giving way to a new global economy marked by higher nominal growth, persistent inflationary pressure, and the reassertion of fiscal reality.”
This shift—away from financial repression by stealth and toward overt tolerance for inflation volatility—frames the entire analysis. The report is not about tactical calls. It is about regime change.
From Liquidity Abundance to Fiscal Constraint
One of the report’s central pillars is the growing dominance of fiscal realities over monetary ambition. Masturzo leads deliberately with debt and deficits, arguing that their scale now exerts outsized influence over central banks, treasuries, and policy credibility.
“Gross U.S. federal debt exceeds 120% of GDP. Europe and Japan are similarly in the red,” he notes plainly. “Higher interest rates make servicing these debts more challenging.”
The uncomfortable implication is that traditional policy responses to economic slowdowns—cutting rates aggressively or expanding fiscal stimulus—are increasingly constrained. Raising taxes or cutting spending is politically untenable. Defaults are unthinkable. That leaves what Masturzo calls the last remaining option: inflating the debt away.
“That leaves financial repression, artificially keeping real rates low to inflate the debt away and boost nominal growth, as the last remaining option,” he writes, adding that “explicit yield curve controls may soon become reality.”
This is not a forecast of imminent collapse, but of diminished policy degrees of freedom—and higher volatility as a result.
Labor Market Strength, with Cracks Beneath the Surface
On the surface, the U.S. labor market in 2025 appeared resilient. Unemployment remained below long-term medians. But Masturzo warns that headline figures masked deeper fragilities.
Annual revisions revealed an overcount of nearly one million jobs. Corporate layoffs accelerated across technology, logistics, and industrial sectors. Meanwhile, nearly 100 “zombie companies”—firms unable to cover interest expenses—re-emerged as a systemic risk.
“While the labor market has been strong, substantive cracks are beginning to show,” Masturzo observes.
Participation rates are also declining again as workers age out or opt out, often because wages fail to keep pace with the rising cost of childcare and elder care. The implication is clear: labor tightness may coexist with weakening employment momentum—a difficult backdrop for policymakers balancing inflation and growth.
Inflation: No Longer a Temporary Guest
Perhaps the most consequential shift described in the paper is not inflation itself, but investor psychology around it.
“Early in the year, the market perceived 3% inflation prints as problematic but now seems to accept 3% as the norm,” Masturzo notes.
Structural forces—energy transition costs, supply-chain reshoring, demographic pressures, and tariff pass-throughs—are expected to keep inflation above central bank targets longer than investors have grown accustomed to. Even where oil prices were subdued in 2025, housing affordability and wage-price divergence remained acute.
The risk, Masturzo cautions, is not runaway inflation—but persistent inflation volatility. That volatility erodes real bond returns, compresses equity multiples, and raises the probability of policy error.
“Run It Hot”: The Policy Choice That Shapes the Cycle
Against this backdrop, Masturzo argues central banks—particularly the Federal Reserve—have implicitly chosen a labor-first approach.
“In 2026, we expect central banks will continue to ‘run it hot’ and add fuel to the fire, lowering rates to spur growth and buoy equities while tolerating higher inflation,” he writes.
This choice carries consequences. Yield curves are likely to steepen. Credit spreads—currently extremely tight—may widen episodically. Mortgage rates may remain stubbornly high even as policy rates fall. Volatility becomes a feature, not a bug.
Asset Class Reality Check: What Worked—and Why
Equities: Strong Returns, Fragile Foundations
Global equities delivered exceptional nominal returns in 2025, aided by a weakening U.S. dollar. But Masturzo repeatedly emphasizes that price appreciation outpaced earnings growth—particularly in the U.S.
“The U.S. CAPE is now 40, near its all-time tech bubble high of 44,” he warns.
By contrast, developed ex-U.S. and emerging markets benefited from cheaper starting valuations and currency tailwinds. The message is not that U.S. equities must crash—but that they are priced for perfection, leaving little margin for error.
Fixed Income: Range-Bound, Not Broken
Despite dire fiscal narratives, long-term U.S. rates remained range-bound throughout 2025. Yield curves began to re-steepen, suggesting future opportunities—but also signaling that bonds will no longer quietly hedge equity risk in all environments.
Credit: Calm Before the Cockroaches?
Credit spreads remained tight, aided by reduced issuance and improved average quality. But Masturzo invokes a memorable warning:
“When you see one cockroach, there are probably more,” quoting JPMorgan’s Jamie Dimon.
With zombie firms proliferating and refinancing risk looming, credit markets may be more fragile than spreads imply.
Emerging Market Local Bonds: A Misunderstood Opportunity
One of the report’s strongest convictions lies in emerging market local currency debt. Improved fiscal frameworks, inflation targeting, and local investor bases have transformed the asset class.
“This translates to a 5.9% index yield…which is cheap relative to similarly rated developed markets,” Masturzo notes.
In a “run-it-hot” environment, these instruments may be structurally advantaged—provided investors diversify broadly.
Inflation-Sensitive Assets: Built for the Regime
TIPS, commodities, real assets, and select alternatives performed their intended role during inflationary stress. Commodities, led by precious metals, delivered standout returns. Importantly, Masturzo frames these not as tactical trades, but as structural components of resilient portfolios.
Long-Term Capital Market Expectations: Valuation Still Matters
The final section pivots from diagnosis to prescription. Expected returns over the next decade, Masturzo argues, remain anchored to starting valuations.
“The relationship between starting valuations and future returns is a reliable measure of expected returns,” he writes.
By that measure, U.S. growth stocks are likely to underperform. Value-oriented strategies, non-U.S. equities, commodities, REITs, and emerging market bonds appear far better positioned.
Key Takeaways for Advisors and Investors
- 2025 marked a regime shift, not a temporary deviation—higher nominal rates, persistent inflation, and volatility are structural.
- Fiscal constraints now shape monetary outcomes, increasing the risk of financial repression and policy trade-offs.
- U.S. equities are priced for perfection, while non-U.S. markets and EM debt offer more attractive long-term fundamentals.
- Inflation-aware diversification is no longer optional—real assets, TIPS, commodities, and alternatives play a critical role.
- Valuation discipline matters more than narratives in a world where liquidity no longer masks risk.
As Masturzo concludes, “Complacency is not an option.” In a fragmented, inflation-tolerant, fiscally constrained world, the investors most likely to succeed will be those willing to diversify globally, embrace volatility thoughtfully, and anchor decisions in fundamentals rather than hope.
Footnote:
Masturzo, Jim. 2025’s Implications for the Future: “Some Like It Hot”. Research Affiliates, Jan. 2026.
