The Federal Reserve’s December projections paint a surprisingly optimistic picture.
After delivering a quarter-point rate cut, the US Fed forecasted that the American economy will showcase resilience, inflation levels will cool around 2% target, but interest rates may stay elevated through 2027.
The central tension is stark as the economy is winning its fight against inflation, yet borrowers won’t see meaningful relief for years.
The Fed’s dot plot signals just one more quarter-point cut in 2026 and another in 2027, suggesting policymakers expect the neutral rate to stay around 3.0% long-term, well above pre-pandemic norms.
Fed upgrades growth despite rate hikes
The Fed upgraded its economic growth forecast in December, projecting 2.3% GDP growth for 2026, a notable acceleration from its September estimate of 1.8%.
Real growth for 2025 came in at 1.7%, slightly better than the prior 1.6% forecast.
These figures directly contradict the recession fears that gripped Wall Street in mid-2024 when aggressive rate hikes sparked warnings of an economic slowdown.
The unemployment rate is expected to stay subdued at 4.5% through 2025 and edge down to 4.4% by 2026, suggesting the job market has navigated rate hikes without significant deterioration.
This is the definition of a soft landing, inflation falling without mass job losses.
The Fed achieved what many doubted possible: a slowing price growth without cratering employment or growth.
For equity investors, this framework suggests a Goldilocks scenario with no recession, inflation moderating, and earnings resilience.
Why higher rates may persist despite cooling inflation?
The whole ‘economy showing resilience’ breaks down for investors as soon as the Fed starts talking about future interest rates.
PCE inflation is projected to fall from 2.9% in 2025 to 2.4% in 2026, approaching the 2.0% target. Core PCE drops from 3.0% to 2.5%, indicating significant disinflationary momentum.
Yet the federal funds rate stays at 3.4% in 2026 and 3.1% in 2027, structurally higher than the pre-pandemic norm of 2.5%.
The disconnect reflects the Fed’s revised understanding of the neutral rate, the theoretical interest rate that neither stimulates nor constrains the economy.
The long-run median forecast sits at 3.0%, implying that even as inflation reaches the 2% target in 2028, rates won’t fall further.
This represents a permanent upward shift from the post-2008 world of 0.5%-1.5% neutral rates.
Mortgage originations, credit card rates, and business loan pricing will remain sticky at elevated levels because the Fed doesn’t expect them to fall dramatically even as inflation recedes.
Markets had priced in 3-4 cuts for 2026 at the start of December.
But, the dot plot’s signal of just one cut suggests the Fed is signaling exactly the message Goldman Sachs warned about: a “hawkish cut” that lowers today’s rates while pulling back on future easing expectations.
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