United States financial conditions as lenders become more risk‑averse.
Just as positive wealth effects boosted consumer spending in early 2026,³ the equity‑price decline generates negative wealth effects that curb household outlays. Unemployment climbs to 7.2% amid the slowdown, further suppressing consumption. Real GDP expands a modest 0.2% in 2027 before shrinking 1.2% in 2028.
As the recession deepens, the Federal Reserve is assumed to cut rates in a series of moves, stabilizing the economy and equity markets. However, the ensuing recovery is projected to be slower than after previous downturns, partly because fiscal stimulus remains limited amid concerns over rising government debt and renewed inflation from large stimulus packages.
Unlike earlier innovation cycles, U.S. AI investments lose relevance over time. Businesses and consumers favor cheaper, low‑investment models, shrinking the customer base for frontier developers. Foreign firms also capture a larger share outside the United States, reducing the economic return on costly frontier models and slowing the rebound of business investment. Real GDP growth during the recovery period of 2029‑2031 averages just 1.5% annually.
Upside: Inflation retrenches while AI investment runs ahead
We assume the average U.S. tariff rate drops to roughly 5% by early next year as more exemptions are granted and courts narrow tariff scopes. Geopolitical tensions ease, easing pressure on commodity prices. Oil is expected to stay below baseline levels, with Brent averaging $86 per barrel in 2026 and $67 in 2027. Stronger net migration adds about 868,000 adults to the population by 2031 relative to the baseline.
Business investment, driven largely by AI activity, remains stronger than in the baseline throughout the forecast, and AI‑related productivity gains begin to lift growth more noticeably from 2028 onward.
Consumer spending stays robust, supported by faster population growth and continued equity gains. The heightened labor demand generated by stronger investment and activity is expected to absorb the additional workers arrivingroves, faster real‑wage growth should further boost household spending. Unemployment stays below the baseline and eventually settles around 4.1%
Business investment, while stronger overall, will be uneven across sectors. Elevated long‑term rates continue to restrain investment in industries with limited AI exposure. However, lower tariffs reduce the cost of imported inputs and capital goods, especially for capital‑intensive firms, offsetting some of the drag from higher financing costs.
Reduced tariffs and lower oil prices help keep inflation in check despite stronger activity. Core inflation is projected to stay slightly below the baseline through Q3 2027, then face modest upward pressure from robust business and consumer demand through 2029, though productivity gains temper those pressures.
Lower near‑term inflation lowers the probability of further Fed rate hikes this year. Strong demand and a relatively tight labor market keep rates steady until early 2028.
Sectors
Labor market
Labor‑market data send mixed signals. Since January 2026, the BLS establishment survey shows non‑farm payrolls up by 643,000, while the household survey reports a decline of 1.2 million jobs.
Given its larger sample and closer alignment with private‑sector data, we view the establishment survey as the more reliable indicator. The pace remains modest, with average monthly gains of about 80,375 over the past eight months, leaving total employment 0.4% above its level a year ago.
This modest growth still outpaces the projected stagnation of the working‑age population, which the Census Bureau expects to remain flat in 2026 and 2027. Consequently, we anticipate employment growth to moderate but stay positive through 2027, then pick up slightly from 2028 to 2031. By 2031, employment growth should be 0.1 percentage point higher than our June forecast.
A slowdown in job creation and a modest decline in labor‑force participation will push the unemployment rate from an average of 4.2% in 2026 to 4.3% in 2028, before it falls back toward 4.1% by 2031. The slight rise in unemployment will temper wage growth briefly, after which wages are expected to accelerate in 2029, aided by AI‑driven productivity gains. Evidence of such gains remains limited, and their timing and magnitude are still uncertain.
Consumer spending
Consumer spending continues to rise. Positive wealth effects and tax cuts have likely bolstered outlays this year. In nominal terms, spending grew 5.9% year‑over‑year in July, while disposable income increased 4.5% and aggregate wages rose 3.5% over the same period. This pattern—spending outpacing income—has persisted since June 2024, widening the gap and driving personal saving rates to very low levels.
The U.S. personal saving rate has hovered at 3% or below since April 2026, a rarity seen in only 41 of the 807 months of available data, most of which occurred during the 2005‑2008 housing bubble.
While this does not necessarily signal a new asset bubble, such low saving rates are unusual. We expect spending to align more closely with income in the coming quarters, allowing the saving rate to rise. The adjustment will likely come from the spending side, as hourly wage growth slows and demographic factors limit rapid employment gains.
We now forecast real consumer spending to expand 2% this year, then decelerate to 1.4% next year. Subsequent improvements in wage and employment growth should lift spending again, reaching a 2.1% real increase by 2031.
Prices
Inflation data have also been mixed. The core CPI (excluding food and energy) rose 2.4% in August, while the core PCE price index increased 3.4% over the same period.
This is noteworthy because historically the CPI registers higher inflation than the PCE, and the two measures are moving in opposite directions. Core PCE prices are accelerating while core CPI is decelerating. Part of the divergence is expected to narrow after a methodological change to the PCE index is released on September 30.⁴
Sequentially, we anticipate core inflation to ease until 2029, when it should return to the Fed’s 2% target.⁵ Persistent above‑trend inflation is likely to be driven by two factors. First, computer software and accessories prices are projected to jump 21.2% year‑over‑year in July, a stark reversal from pre‑pandemic declines. Some of this rise reflects methodological quirks, but upward pressure is expected to remain even after adjustments.
Second, housing costs will add to inflationary pressure. After easing through late 2025, the CPI’s housing component has stabilized, but private‑sector data show rental prices beginning to rise again, which will feed inflation with a lag.
Tariffs have contributed to price pressures, though most tariffs introduced last year have already been passed on to consumers.⁶ While tariff policy continues to evolve, we expect the average rate to stay relatively stable, limiting further price impacts.
We assume crude oil prices will decline over the next two years, helping to lower headline inflation, though ongoing Middle‑East conflicts introduce uncertainty. Elevated inflation expectations also pose a risk of making actual inflation more persistent than our baseline assumes.⁷
Business investment
A key revision to the forecast is a higher pace of business investment. Previously we projected real business investment to grow 6% this year and 4.9% next year; we now expect 6.6% and 5.1%, respectively. This upgrade reflects upward revisions to historical data and a stronger‑than‑expected second quarter.
Recent capital‑expenditure announcements from hyperscalers also influence the outlook. While they plan roughly 40% growth next year to exceed $1.1 trillion, this is slower than the roughly 75% increase anticipated for this year.
These sizable plans are already shaping overall investment trends. In Q2, real investment in information‑processing equipment rose 22.2% year‑over‑year, and software investment climbed 10.8%.
Growth in AI‑related spending is expected to remain robust, but other categories stay weak. Real investment in structures fell 4.5% year‑over‑year in Q2, and transportation equipment investment declined 6.1%. Higher borrowing costs and rising input prices continue to weigh on capital spending outside the tech sector, and heightened uncertainty is likely to keep investment growth modest. We anticipate modest contractions in structures and transportation equipment investment into next year.
Monetary policy and interest rates
After three quarter‑point cuts in the latter half of last year, the Fed raised rates at its September meeting. We now expect one more hike before year‑end. As consumer spending growth and inflation ease in 2027, the Fed is likely to resume rate cuts at that year’s end.
Our outlook for the 10‑year Treasury yield has risen sharply. Longer‑term yields have climbed not only because of the anticipated Fed hike but also due to higher expected debt issuance for AI projects and relatively loose fiscal stances in major economies, which increase supply. We now project the 10‑year yield to stay above 4.5% through 2027, then converge toward 4.2% as the Fed cuts rates.
Higher long‑term yields have pushed mortgage rates up. We expect 30‑year fixed‑rate mortgages to remain above 6.5% through 2027 and not fall below 6% before the end of 2031. Consequently, residential investment is projected to stay weak, contracting 3.4% this year and growing less than 1% in 2027. Housing construction will likely face further constraints from rapidly rising material and labor costs.
