A new Federal Reserve chair will be nominated soon to replace Jerome Powell, whose term ends in May. But the economy may prevent the central bank from lowering rates as much as President Donald Trump would like, according to Capital Economics.
In a note on Thursday, economists said the recent investment surge led by artificial intelligence is just the start of a multiyear boom in capital spending.
As a result, GDP with grow at a robust rate of 2.5% in both 2026 and 2027, even after accounting for a weaker job market that will slow consumption.
“With core inflation remaining above the 2% target for some considerable time, we think the Fed will cut its policy rate by only 25bp in 2026, putting the new Fed Chair and President Trump at loggerheads almost immediately,” Capital Economics predicted.
The president is considering National Economic Council Director Kevin Hassett, Fed governor Christopher Waller, and former Fed governor Kevin Warsh. The prediction market Kalshi has Hassett as the favorite with 54% odds to be picked, followed by Warsh (24%) and Waller (14%).
On Wednesday, Trump said he will name someone “who believes in lower interest rates by a lot.” A week before that, after the Fed cut rates by a quarter point to 3.5%-3.75%, he complained that it could have been “at least doubled.”
And earlier this year, Trump suggested the rate should go all the way down to just 1%, a level that’s typically consist with a recession, not an economy expanding at a healthy clip.
To be sure, the job market is showing signs of stagnation, but the AI boom will keep the economy buoyant, with incomes holding up too, Capital Economics said.
That’s as business investment should grow by 6.5% in 2026 and accelerate to a 7.4% pace in 2027, as AI adoption spreads to more sectors outside tech, like finance, real estate and healthcare.
AI-fueled productivity gains should also help offset tightness in the labor market due to Trump immigration crackdown, but his tariffs will keep inflation sticky, economists said.
Of course, Trump’s Fed pick could do his bidding and push for more rate cuts, but that will require other policymakers to go along. And even if they do, the aggressive easing will eventually backfire.
“Admittedly, the appointment of a new Fed Chair could trigger a bigger wave of policy loosening, but only if the Trump administration is willing to destroy the FOMC’s independence and inflation-fighting credibility, which may result in higher long-term interest rates,” Capital Economics warned.
For his part, Hassett seemed to display a rare hint of independence from Trump last week, saying the president’s opinion would have “no weight” on the rate-setting Federal Open Market Committee.
Not everyone is so bullish on the economy. Analysts at Citi Research expect GDP growth of around 2% next year with inflation heading toward the Fed’s 2% target and the labor market continuing to soften.
That will clear the war for the Fed to cut rates by a total of 75 basis points—triple what Capital Economics sees—to 2.75%-3.0%.
“Risks are balanced toward a more rapid rise in the unemployment rate that could lead the Fed to cut rates more rapidly and deeply,” Citi said in a note Thursday. “We do not expect a rebound in growth or labor demand in 2026. Instead, our base case is for hiring to remain subdued leading to slower income growth and a sustained slowdown in consumer spending.”
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