What’s Ahead in 2027 and Beyond for Inflation, Fed Rate Cuts, and More

The Federal Reserve hiked interest rates in its September 2026 meeting. But we expect the Fed to return to rate cuts in 2027 and 2028, as inflation cools and economic growth slows. Lower interest rates will enable gross domestic product growth to reaccelerate in the later years of our forecast.

GDP Growth to Slow Further Through 2027

GDP growth has been trending down, posting at 2.1% in 2025, 0.7 percentage points lower than the 2022-24 average of 2.8%. One theme is policy change, including the impact of tariffs and lower population growth via immigration. Another driver is the lingering effect of high interest rates. Total private fixed investment, excluding technology-related categories buoyed by artificial intelligence, has been contracting since 2025.

We expect these headwinds to persist. Meanwhile, the boost to GDP growth from AI will diminish as spending grows at a more reasonable pace. That causes GDP growth to dip a bit further by 2028. Slower GDP growth reduces the demand for workers, so we expect the unemployment rate to tick up to an average of 4.7% in 2028 from 4.3% in 2025.

Easing monetary policy, rebounding population growth, and other factors should drive a rebound in GDP growth in the later years of our forecast.

Inflation to Resume Falling After 2026

In 2025, the previous downward trend in inflation ceased, with inflation holding at 2.6%. About 0.2 percentage points of inflation in 2025 were owed to the impact of tariffs on core goods prices. In 2026, inflation is set to average about 3.4%. The main driver is the Iran war, as higher oil prices contribute about 0.8 percentage points to our 2026 inflation forecast.

We expect inflation to fall in the coming years. Receding energy prices will be reflected in a negative impulse to inflation in 2027. The tariff impact should also cease going forward. Moreover, wage growth has slowed considerably, which should help push services inflation back to normal. Housing inflation also continues to trend down.

Rate Cuts Still Coming After 2026 Hikes

Markets are now expecting around three or four rate hikes through mid-2027. Equally important, the market is expecting this high target range of 4.25%-4.50% to be held indefinitely (that is, as the “terminal” rate).

We’re in line with the market in the near term, expecting two rate hikes through the end of 2026. After that, our view diverges from the market. Based on our forecasts for inflation, GDP growth, and unemployment, we expect the Fed to return to cutting after this year. We expect progress on core inflation along with weakening growth to push the Fed to cut rates twice in the second half of 2027. We expect a further four rate cuts in 2028 as unemployment averages 4.7% that year, above the Fed’s expectation of 4.1%.

Altogether, that will bring the federal-funds rate down to 2.50%-2.75% by the end of 2028, 1 percentage point below the current rate. Our expectations are 175 basis points below the market expectations. We believe the market’s terminal rate is much too high.

In our view, substantial further interest rate cuts will be needed to drive longer-run borrowing rates down and thereby support continued robust economic growth. Another 1.00 percentage points in federal-funds rate cuts through 2028 should drive the 10-year yield to an average of 3.50% by 2029, which is our long-run expectation.

Longer-term interest rates are at or above peak levels, despite federal-funds rates being below the 2023-24 peak. As mentioned, that’s because of a mixture of rising terminal rate expectations as well as the term premium. Regardless, it means that key borrowing rates affecting the real economy, like the 30-year mortgage rate, stand painfully high.

Currently, AI is boosting aggregate demand, putting upward pressure on interest rates. That effect is coming via the gargantuan investment spending, as well as the tremendous runup in stock prices causing a consumer wealth effect. But for the investment and stock prices to be justified, we’ll almost certainly have to see large job cuts eventually. Such cuts haven’t occurred so far, but when they do, that will depress aggregate demand. If the job cuts don’t occur, then AI spending will have to contract for lack of return on investment. Either way, that means AI’s upward pressure on interest rates will subside to a great degree.