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

It looks likely now that the Federal Reserve will return to hiking interest rates this fall. But we don’t expect this to last for long. In fact, 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 over 2027-28. Slower GDP growth reduces the demand for workers, so we expect the unemployment rate to tick up to an average of 4.6% in 2027 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 will rise to 3.4%. The main driver is the Iran war, as higher oil prices contribute about 0.6 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, but a Near-Term Increase Is Now Likely

The futures market is now expecting two federal-funds rate hikes for the remainder of 2026. We wouldn’t go this far, partly because we think this reflects an overreaction to the turnaround in the labor market data as well as hotter core inflation in the first half of 2026.

But we do now expect one hike of 25 basis points this year (in September), whereas previously we expected flat rates. That’s because we can discern a hawkish shift in the mindset of Fed officials, as seen in the June FOMC meeting minutes.

But based on our forecasts for inflation, GDP growth, and unemployment, we expect the Fed to return to cutting after this year. We expect three cuts in 2027 and two more in 2028. Netting out the expected 2026 hike with the 2027 and 2028 cuts, that’s a cumulative 1 percentage point reduction to the federal-funds rate. That will bring the fed-funds rate to a target range of 2.50%-2.75% at the end of 2028, down from 3.50%-3.75% currently.

The market expects just one cut in the federal-funds rate (sometime in 2028) following the two hikes this year. That translates into a federal-funds rate 1.25 percentage points above our forecast by the end of 2028. That divergence is also paralleled in the 10-year Treasury yield (remember, long-term bond yields reflect the market’s expectation of the future federal-funds rate). We expect the 10-year Treasury yield to drop to 3.5% in 2029 and beyond, well under its current yield of 4.6%.

In our view, substantial further interest rate cuts will be needed to drive longer-run borrowing rates down, thereby supporting continued, robust economic growth. If the Fed fails to loosen monetary policy in line with our forecasts, we believe economic growth will ultimately slow to the point of compelling it to do so.