The economic assumptions that broke
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Illustration: Aïda Amer/Axios
Many of the assumptions that underpinned forecasts for the Federal Reserve, inflation, hiring, trade and growth have been upended in just six months, forcing policymakers and investors to rewrite their playbooks.
Why it matters: The rapid shifts suggest structural forces — from AI to geopolitics to changing labor supply — are playing a much larger role in the economy than they have in decades.
- It leaves policymakers, businesses and investors with less confidence about what comes next in the second half of the year and beyond.
The intrigue: At the end of last year, policymakers largely believed that 2026 would be defined by continued progress on inflation, allowing interest rates to gradually move lower.
- Today, they are confronting an unforeseen reality: Inflation has reemerged as the Fed's primary concern, forcing policymakers to rethink how restrictive policy may need to remain.
For a sign of the head-spinning shift, consider the Fed's own forecasts.
- In December, the median Fed official expected inflation to cool to 2.4% by the end of 2026. Six months on, the median inflation forecast has jumped to 3.6%.
- No policymaker in December expected rate increases in 2026. By last month, roughly a third of officials did.
State of play: Brent crude oil has fallen back to about $72 a barrel, essentially where it traded before the Iran war in March.
- The two-year Treasury yield has climbed to roughly 4.18%, from 3.47% at the start of the year, reflecting a market that expects inflation pressures to outlast the latest energy shock.
The big picture: Unemployment forecasts among Fed officials and other economic forecasters have barely budged in the past six months.
- Behind that stability, though, economists are much less certain about one of the labor market's most important guideposts: the pace of job growth needed to keep unemployment steady.
- Unemployment has held at 4.3%, despite payroll gains averaging nearly 190,000 over the past three months. This suggests the economy may require more job growth to keep unemployment stable than the near-zero break-even estimates that gained traction earlier this year implied.
Between the lines: AI-related investment accounted for roughly 0.8 percentage points of the economy's 2.1% annualized growth in the first quarter.
- In the second quarter, the Atlanta Fed is tracking 2.5% GDP growth alongside another quarter of robust business investment, suggesting the AI capex boom remains a key pillar of economic growth.
Yes, but: Six months ago, the AI conversation focused on its eventual impact on productivity and jobs. Today, the focus is on the inflationary consequences of building the infrastructure needed to get there.
"When nearly $1 trillion in AI investment chases resources that aren't easily scalable, the outcome is likely to be inflationary — at least initially," Barclay economists wrote this week.
- They estimate the AI buildout has added as much as a quarter-percentage point to inflation since January through higher electricity demand and soaring memory chip prices.
The bottom line: Many of the assumptions that shaped the economic outlook at the start of the year have already been rewritten.
- More uncertainty in the next half looks likely: Fed chairman Kevin Warsh has signaled a break from the Fed's recent communication strategy, offering less forward guidance on the path of interest rates and placing greater emphasis on how the data evolves.
