The Federal Reserve is about to restart the "rate-cutting cycle." Goldman Sachs: Fiscal and monetary easing, a new Federal Reserve chairman, and AI stimulation will all drive up assets and inflation next year

The Federal Reserve is expected to initiate its first interest rate cut of the year next week, followed by continued cuts until the end of the year.

However, Goldman Sachs strategists warn that the upcoming rate-cutting cycle will be relatively straightforward this year, but may face complexities in 2026—such as a shift to accommodative fiscal policy, the dovish tendencies of the new Federal Reserve Chair, and productivity gains driven by AI, all of which could push up asset prices and inflation expectations.

Clear Rate Cut Path, Labor Market Softening Provides Support

Goldman Sachs believes that the U.S. labor market is currently in a trend of softening. The comprehensive indicator of labor market tightness—which includes unemployment rates, job vacancies, turnover rates, and business and consumer survey data—is expected to stabilize briefly at the end of 2024/beginning of 2025 before declining again.

Despite significant uncertainty regarding actual employment growth, the unemployment rate has already risen. Under political pressure, the Federal Reserve does not want to fall behind the situation in its policy adjustments, thus it tends to normalize the policy rate (lower it to) a level closer to neutral.

Goldman Sachs anticipates that even if tariff transmission pushes core PCE to 3.2% in the fourth quarter, this will be a temporary price level shock. In labor-intensive industries, inflation should steadily decline as a weak labor market further suppresses wage growth.

Physical Assets Benefit, Inflation Expectations Rise

However, when the policy rate approaches 3%, the decision-making facing the Federal Reserve will become more complex. Goldman Sachs points out that unless the labor market deteriorates sharply and signs of economic recession appear, there will be multiple intersecting factors in 2026.

The market will continue to price in a dovish premium for the terminal rate during Trump's term, especially after the new Federal Reserve Chair takes office. In other words, the probability of interest rate hikes during Trump's term is low, which has already been reflected in the probability distribution of the terminal rate.

Since early June, the U.S. financial conditions index has further eased by 75 basis points, with each component contributing, and the stock market being the largest driving factor. Meanwhile, potential GDP is expanding at about 2.25%, with strong productivity growth offsetting the negative impact of reduced immigration.

Goldman Sachs expects that as the drag effect of high tariffs diminishes and fiscal policy turns more expansionary, the U.S. economy will gradually re-accelerate to potential growth levels by 2026. The current key question is: to what level can AI technology push this figure?

Goldman Sachs concludes that in a scenario without entering an economic recession, if rate cuts continue next year, policy adjustments may become trickier. Faced with accommodative financial conditions, active fiscal stimulus, and tail risks from AI technology, the dovish new Federal Reserve Chair increases the likelihood of economic re-acceleration next year, which will support physical assets and inflation premiums