Market Update: We break down the business implications, market impact, and expert insights related to Market Update: US Economic Forecast Q4 2025 – Full Analysis.
Scenarios
Baseline
Our baseline forecast is closest to how we expect the economy will grow, based on the assumptions made at the time of analysis. We expect that the average tariff rate will remain high throughout the forecast period (2025 to 2030), though the country- and product-specific rates are likely to change. As of August, the average effective tariff rate was just above 10%, up from about 2.5% at the start of the year.3 We assume that this rate rises further to 15% by the first quarter of 2026. Importers who built up their inventories ahead of tariffs will ultimately need to replenish those goods at tariffed rates, as domestic production has not fundamentally changed. This is expected to raise the average effective tariff rate to about 15%. We assume this average tariff rate persists through the end of 2030. However, exemptions, court rulings, or a new administration could lead to deviations from this assumption.
We have also maintained our assumption that net migration into the United States is lower than we had anticipated during the first half of 2025. In January, the Congressional Budget Office (CBO) had anticipated that net migration into the United States in 2025 through 2030 would amount to 6.8 million adults.4 In September, the CBO revised this estimate down to 4 million adults.5 However, based on recent trends in immigration statistics,6 we have assumed net migration of 3.3 million adults over that period. This puts downward pressure on the forecast, as fewer workers contribute to economic output. The lost output accumulates over time, making growth weaker over longer time horizons.
Artificial intelligence is already having a sizable effect on the economy. In the baseline, we have increased the level of business investment relative to our September forecast. This partially reflects the release of stronger data. For example, real business fixed investment in the second quarter of 2025 was initially reported to have grown an annualized 1.9% from the previous quarter. However, that figure was revised up to 7.3%. Although we expect investment to remain relatively strong in the next few years, the growth rate is expected to moderate from 4.4% in 2025 to 4% in 2026.
Similarly, real consumer spending is expected to be stronger in the near term, thanks to AI-driven gains in equity prices. This positive wealth effect helps to explain why aggregate consumer spending has grown faster than aggregate wages. Here, too, some of the anticipated strength in consumer spending comes from upward revisions to the data. The annualized growth rate of real consumer spending between the first and second quarters of 2025 was revised from 1.4% to 2.5%. As equity-price gains slow, we expect consumer spending growth to fall into better alignment with wage growth.
Consumers, however, face some serious headwinds. High tariffs increasingly show up in consumer prices, raising the core personal consumption expenditure (PCE) price index 3% in 2026. This is lower than what had been forecasted in September. We now anticipate that businesses will pass tariff costs on to consumers more gradually, keeping core inflation above the Federal Reserve’s 2% target until the end of 2028.
A loosening labor market is expected to push wage growth lower, eroding purchasing power and consumer spending. In addition, weaker population growth from a sharp drop in net migration weighs on aggregate consumer spending. As a result, real consumer spending slows to 1.6% in 2026, down from an anticipated 2.6% in 2025. Unemployment rate rises to 4.5% in 2026, up from 4% in 2024. Despite the pronounced slowdown in consumer spending, real GDP is expected to grow 1.9% in 2026, down slightly from an anticipated 2% in 2025. By 2030, real GDP growth is expected to shift to its potential rate of about 1.8%.
Downside: AI goes from boom to bust
Our downside scenario maintains the same tariff and immigration assumptions that were made in the baseline. However, it assumes that investment in AI becomes overdone, leading to a relatively sharp pullback in business spending in 2027 as companies reassess potential demand for related products. Real business investment is expected to decline by 2.1% in 2027 and another 0.3% in 2028.
Although the contraction in business investment is significant, it is considerably smaller than contractions seen in previous recessions. The peak-to-trough decline in our downside scenario is less than half of the decline seen after the dot-com bubble and less than a quarter of that seen during the Great Recession. This occurs for two reasons. First, businesses unrelated to artificial intelligence have already tightened their belts, which should limit additional declines should AI-related investment prove to be a bubble.
The second reason is that the depreciation cycle for many of the components in AI-related investments is likely much shorter than it was for fiber-optic cables during the telecom boom in the late 1990s. The fiber-optic cables that were initially laid remained useful years later when demand finally caught up. However, this is unlikely to be true for AI infrastructure. Rising obsolescence of existing AI infrastructure will likely force companies to make new investments to just maintain existing capabilities and could need to spend even more to prevent moving further from the technological frontier.
As companies pull back on their investments in artificial intelligence and investors realize that demand for related products will be weaker than previously anticipated, stock prices are expected to fall roughly 10% from peak to trough. This brings price-to-earnings ratios to less optimistic levels than those seen through much of 2025. This sudden drop in wealth has an outsized effect on consumer spending. Recently, consumer spending growth has been heavily dependent on top income earners7 who are likely more influenced by changes in their financial portfolios. As a result, we expect real consumer spending to fall 0.2% in 2027 and grow by just 0.3% in 2028.
The weakening of domestic demand raises the unemployment rate to 5.5% in 2028. It also provides a stronger disinflationary impulse, allowing core PCE price index growth to dip below the Fed’s 2% target by the end of 2027 before returning to 2% by 2030. As a result, the midpoint of the federal funds rate drops below 1% by the end of 2027. Real GDP is expected to decline 0.2% in 2027 and grow just 0.8% in 2028. A stronger recovery is expected to take hold in 2029 and 2030.
Upside: AI investment boom endures
The upside scenario assumes that the tariff rate falls to about 7.5% by the end of 2026. We assume that Canada and Mexico secure favorable trade deals by the second half of 2026 under a revised United States–Mexico–Canada Agreement (USMCA). Moreover, we assume that product exemptions, court rulings, and additional trade deals lower the average tariff rate further. We also assume that net migration is stronger than in the baseline, lifting the adult population by about 1.7 million people by 2030 relative to the baseline. Business investment—driven by investments in AI—is expected to grow sustainably stronger than the baseline till the end of the forecast period in 2030.
Despite much lower tariffs and stronger business investment, the US economy is still expected to grow at a slower rate in 2025 compared with the previous two years. It is not until 2026 that the effect of the difference in tariff rates shows up more clearly in the inflation data. The rise in prices has been gradual so far since firms are absorbing the impact of tariffs.8 However, rising prices cause consumption to decelerate from recent years even though it’s considerably stronger relative to baseline. Strong immigration also puts upward pressure on aggregate demand. As a result, real consumer spending would expand by 2.2% in 2026, albeit lower than the 2.6% expected in 2025.
With an uptick in inflation, the Fed will likely take a more balanced approach to monetary policy. We assume the Fed leaves rates unchanged until December 2026. The average federal funds rate reaches its neutral 3.125% in the middle of 2027.
The yield on the 10-year Treasury in the upside scenario is expected to be higher than the baseline in the short term, till about middle of 2027, as investors see inflationary pressures continuing and the Fed adopting a more balanced monetary policy stance as a result. The 10-year Treasury yield will ease gradually between the third quarter of 2025 and the second quarter of 2027, to settle at 3.9% from the third quarter of 2027 through the end of 2030.
Business investment is expected to remain relatively strong throughout the forecast period. AI-related spending is expected to continue to fuel business investment in the next few years. With lower interest rates, stronger economic growth, and fewer tariff-related costs, business investment continues to accelerate, maintaining stronger growth between 2026 and 2028 compared with the baseline. Real business fixed investment is expected to grow 4.4% in 2026 and 3.8% in 2027.