Will Interest Rates Fall More in 2026? Our Latest Forecast

Core Viewpoint - Tension exists between the Federal Reserve's goals of controlling inflation and supporting the job market, leading to a cautious approach in interest rate decisions as inflation remains high and the job market shows signs of weakness [1] Interest Rate Decisions - The Federal Reserve cut interest rates by 0.25% as expected, but there were dissenting opinions within the committee, indicating differing views on the necessity of further cuts [2][4] - The Fed has cumulatively cut rates by 1.75 percentage points since September 2024, with current rates in the target range of 3.25% to 3.5%, still above pre-pandemic levels [5][19] - The Fed is expected to pause further cuts in January, with forecasts suggesting only one additional cut next year, contrasting with some analysts predicting two cuts [6][7] Economic Indicators - The natural rate of interest is believed to be closer to pre-pandemic levels, influenced by demographic trends and economic growth rates [9][20] - The housing market continues to weaken despite rate cuts, indicating potential need for further cuts to support this sector [10] - The lack of recent GDP data creates uncertainty in assessing the overall economic picture, with expectations for updates once Q3 data is available [11][12] Inflation and Tariff Policies - Factors that could lead to more aggressive rate cuts include a significant downturn in the AI sector, which has been a major contributor to GDP growth [12] - Tariff policies present a risk for inflation; if businesses pass on tariff costs to consumers, it could increase inflationary pressures, complicating the Fed's monetary policy [13][14] Neutral Interest Rate - The neutral interest rate is crucial for balancing full employment and inflation at the Fed's 2% target, with current rates slightly above the estimated neutral level of around 3% [15][19] - The neutral rate has trended down over decades, influenced by demographic changes and economic growth, suggesting that the Fed's long-term rate setting will align with this metric [21][22]