Pantheon Macroeconomics expects the Federal Open Market Committee to shift toward substantial policy easing next year, lowering the federal funds rate from its current 3.75%-4.00% target range to 3.125% by the end of 2026. Even though another 25-basis-point hike this year remains a near-term risk, driven by surging energy costs that are pushing up core goods prices, the key catalyst for this pivot is weakening consumer demand.

In a recent report, Pantheon noted that strong household spending earlier this year was supported by large spring tax refunds and rising stock prices, but much of that cash now appears to have been spent or used to pay down debt. As refund support fades and balance sheet pressures intensify for lower-income families, spending growth is projected to slow markedly in the fourth quarter of 2026 and the first quarter of 2027.

Lower-income households will also feel the impact of stricter Medicaid and SNAP eligibility requirements in 2027. Meanwhile, core PCE inflation is expected to stay largely unchanged until late 2026, followed by significant progress toward the 2% target in the first half of 2027, as tariff- and energy-related price increases drop out of the year-over-year comparison base.

Labor market dynamics further reinforce the case for easing. Pantheon points out that job growth has slowed to a trend pace of about 75,000 per month in preliminary estimates, though revisions could bring that closer to 25,000. At the same time, AI's adverse effects on labor demand are accumulating, particularly in high-usage sectors such as information, finance, and professional services.

Historically, the Fed has moved quickly when shifting direction: over the past four decades, the average interval between the last hike in a tightening cycle and the first cut has been just six months. With a Fed chair appointed by a president who continues to push for lower rates, and fiscal policy no longer boosting GDP growth, building consensus around rate cuts should become easier as 2027 unfolds.