Fed will return to rate cuts in 2027 on consumer fatigue

Pantheon Macroeconomics forecasts that the Federal Open Market Committee will pivot to material policy easing next year, lowering the federal funds rate to 3.125% by year-end from the current 3.75%-4.00% target range—even as another 25-basis-point hike remains a near-term risk this year due to surging energy USO BNO costs lifting core goods prices.

The expected shift hinges on consumer fatigue. This year’s robust household spending was powered by substantial tax refunds in the spring and rising stock SPY DIA QQQ prices, but most of that cash appears to have been spent or used to pay down debt, Pantheon wrote in a note.

Growth in spending should slow markedly in Q4 2026 and Q1 2027 as support from refunds fades and pressure on lower-income balance sheets intensifies, the note said. Lower-income households will also feel the effects of tighter Medicaid and SNAP eligibility requirements in 2027.

Meanwhile, core PCE inflation is expected to remain broadly unchanged through late 2026 before making significant progress toward the 2% target in the first half of 2027, once tariff- and energy-related price increases drop out of year-over-year comparisons.

Labor market dynamics reinforce the case for easing. Payroll growth has slowed to a trend of roughly 75K per month in initial estimates—likely closer to 25K after revisions—while AI’s adverse impact on labor demand is building, particularly in high-usage sectors like information, finance, and professional services.

Historically, Pantheon noted, the Fed has pivoted quickly: the average interval between the last hike in a tightening cycle and the first cut has been just six months over the past 40 years. With Fed Chair Warsh appointed by a president who has pressed for lower rates, and fiscal policy no longer boosting GDP growth, building consensus around cuts should become easier as 2027 unfolds.