The FOMC is optimistic on growth and inflation. Westpac sees uncertainty on both fronts.
The FOMC cut the fed funds rate by 25bps to a midpoint of 3.625% at their December meeting as the market had hoped. However, the Committee held to September’s projection of just one more cut in 2026 and another in 2027 to a broadly neutral rate of 3.125% by end-2027 compared to the market’s expectation for a return to neutral policy by end-2026.
Warranting a slow normalisation of policy, the FOMC now expects above-trend growth in 2027 (2.3% from 1.8% in September) and 2028 (2.0% from 1.9%), arguably because of support for consumption from real income growth and as the AI-related infrastructure build out continues. In the press conference, Chair Powell also noted that 0.2ppts of growth had been transferred from 2025 to 2026 because of late-2025’s Government shutdown. The unemployment rate profile is little changed, expected to grind lower to the full employment level of 4.2% in 2028.
The Committee showed little concern over the inflation outlook, with a measured descent in annual core inflation forecast from 3.0% in 2025 to 2.5% in 2026, then 2.1% in 2027 and 2.0% in 2028. In effect, moderately restrictive policy is expected to prove successful over time, allowing the FOMC to meet both sides of its mandate.
Westpac believes the US faces material capacity constraints across power, logistics and other essential services owing to a lack of breadth in business investment and given migration reform. We expect this constraint to hold activity growth around trend, versus the FOMC’s more optimistic view, and to result in greater persistence in inflation and associated risks.
Our forward view for the fed funds rate is consistent with the FOMC’s for 2026, with the cut most likely to come in early-2026 before inflation’s persistence becomes a concern. But thereafter we expect the Committee to remain on hold at 3.375% and for inflation risks to bias up long-term yields, along with growing fiscal uncertainty.
