Issue link: https://nebusinessmedia.uberflip.com/i/1542466
20 HARTFORDBUSINESS.COM | JANUARY 12, 2026 From uncertainty to growth: reasons for optimism in 2026 By Kenneth J. Entenmann T his past year was marked by uncertainty with a few key themes shaping a highly volatile economic environment. Those themes were artificial intelligence (AI), tariffs, immigration and employment, tax policy and regulatory policy. Given the uncertainty surrounding these themes, businesses entered 2025 in a very cautious mood, effectively calling a corporate "time out" in the first half of 2025 as they assessed the uncertainty. Business investment and hiring slowed early this year, contributing to a weak start to 2025 as the economy contracted at a 0.6% annual rate in the first quarter — the first negative growth since the second quarter of 2022. However, the economy recovered for the rest of the year, growing more than 3% in the second and third quarters. The labor market continued to modestly decline throughout the balance of the year, with the unemployment rate rising from 3.8% to 4.6%. Inflation improved modestly but remained "sticky." The combination of a slowing labor market and flat-lining inflation allowed the Federal Reserve Bank to resume its monetary easing policy, cutting rates three times since September. Given the vast uncertainty at the beginning of the year, the economic performance of the U.S. economy in 2025 was quite remarkable. The record shows accelerating GDP growth, a solid albeit slowing labor market, modest inflation, lower interest rates and record level equity markets. Not bad for a year of uncertainty. Looking ahead to 2026, the themes that dominated 2025 remain, but many are more certain. While some uncertainty continues, there are reasons for optimism. One of the most prominent reasons for optimism is the rapid advancement of AI. The prospects of AI have been driving economic activity and the equity markets. As AI develops, it is becoming clearer that it will have a material impact on productivity throughout the economy. Doing more with less allows businesses to increase product offerings, reduce costs and explore new markets. Massive capital expenditures on AI programming and AI infrastructure will help to stimulate the economy in 2026. This spending has catapulted U.S. equity markets to record high levels and valuations. Indeed, the S&P 500 Index is on track for its third consecutive year of double-digit returns! In turn, the "wealth effect" of higher equity markets helps fuel consumer spending, the primary driver of the U.S. economy. It is likely that AI's influence on the economy will be increasingly more impactful. Perhaps the most controversial economic driver in 2025 was tariff policy. Indeed, tariffs are mainly responsible for the huge swings in GDP growth in the first half of 2025. April 2 was dubbed "Liberation Day" and marked the start of the Trump administration's tariff policy. At the start, this day was a catalyst for serious market correction, as the S&P 500 plunged by nearly 20% over the course of six weeks, ending April 8. The 0.6% decline in first-quarter GDP was largely the result of import- dependent businesses front-running tariff implementation. Similarly, the 3.8% growth rate in the second quarter largely reflected a reversal of that earlier impact. Many economists forecast a significant increase in inflation. However, tariff policy began to morph almost as soon as it was announced. Initial start dates were delayed as countries began to negotiate new trade agreements. And then they were delayed repeatedly. Several new trade deals were consummated, reducing the overall impact of tariffs. Recently, tariffs on certain food items like bananas and coffee were withdrawn. Overall, the greatest fears of tariff policy failed to materialize. To be clear, some industries were impacted more than others; small businesses like the ones that dominate the Greater Hartford economy were hurt far more than large companies. Small companies simply do not have the pricing power and vendor control that large companies do. Despite all the vitriol, angst and uncertainty surrounding tariffs, their impact on the economy was modest. GDP was modestly lower, and inflation was modestly higher by about 0.5%. Not a great outcome, but not the predicted catastrophe. Regardless of how one feels about tariffs, the good news is their impact on inflation should diminish in 2026. Historically, tariffs have a one-time impact on inflation. In addition, it is likely that more tariffs will be rescinded in 2026 as new agreements are finalized. This year's economic outlook survey results note concern from respondents regarding the labor market, inflation and interest rates. The Federal Reserve is struggling with these same factors. The Fed has a dual mandate: to maximize employment and maintain price stability, or control inflation. This sticks the Fed between a rock and a hard place. On one hand, the labor market cooled in 2025, with the unemployment rate rising to 4.6% in November. Companies continue to reconcile the huge post-COVID hiring and the following hoarding of labor, particularly in the technology sector. Immigration policy has reduced the size of the available labor force. There is a fear that AI will crimp employment. Nonetheless, small businesses, as noted in the survey, continue to find it difficult to hire qualified workers. In short, the labor market is in a low-fire, low-hire mode. Even so, with unemployment at 4.6%, it remains in relatively solid shape. On the other hand, inflation remains a concern for business and the Fed. As noted above, tariffs are a big part of this concern but should have a diminishing impact. The Consumer Price Index (CPI) has improved from its June 2022 peak of 9.2%. Yet throughout 2025, CPI remained stuck in a narrow range of about 2.8% to 3.1%. November CPI showed encouraging progress, coming in at 2.7%. Still, the Fed remains in a tough spot: Should it lower interest rates to stimulate a slowing labor market, or hold them steady to guard against inflation? The Fed has already opted in favor of its employment mandate, lowering rates three times in the fourth quarter of 2025. Entering 2026, the effective Fed Funds rate is 3.5% to 3.75%, down from a peak of 5.5%. However, businesses should manage their expectations for further improvements in interest rates. Indeed, the Fed's December meeting vote demonstrates the Fed's dilemma. Dissents on Fed policy votes are highly unusual. Yet, at the last meeting, there were three dissents! One member wanted a 0.5% rate cut, while two members wanted to keep rates unchanged. Yes, it is unclear whether interest rates will continue to decline in 2026, but the good news is rates are unlikely to go up. The recent lowering of interest rates should provide stimulus to the overall economy in 2026. Businesses will enter 2026 with greater tax certainty following passage of the so-called "Big, Beautiful Bill" in July 2025, which preserved the 21% corporate tax rate and codified full expensing of capital expenditures and favorable tax treatment for long-term fixed investment, strengthening incentives to invest. In addition, the recent passage of the National Defense Authorization Act will generate $900 billion in defense spending, which should provide a significant boost to the Connecticut economy. Lastly, efforts to decrease regulation, particularly as it relates to the labyrinth of the permitting process, should also help to stimulate the economy. 2025 was a year filled with announcements of plans to build tech infrastructure and manufacturing plants across the country. Hopefully, with tax certainty and regulatory relief, 2026 will be the year when the shovels hit the ground. As we enter 2026, there are reasons for optimism. Kenneth J. Entenmann is NBT Bank's Chief Economist and Chief Investment Officer. Kenneth J. Entenmann