CBO Projects Fed Rate Cuts Later in 2026: Unemployment to Peak at 4.6% Before Easing

The nonpartisan Congressional Budget Office delivered its latest economic crystal ball on Thursday, projecting that the Federal Reserve will resume cutting interest rates in 2026 while unemployment peaks at 4.6% before gradually declining. The report provides a comprehensive view of how Trump administration policies—including tariffs, immigration restrictions, and the "One Big Beautiful Bill"—are reshaping the economic landscape.

According to the CBO, the Federal Reserve's key interest rate is expected to settle at 3.4% by the end of President Trump's term in 2028, down from the current target range of 3.5% to 3.75%. The projection suggests a measured pace of easing, with markets currently pricing in just two quarter-point cuts for 2026.

The Unemployment Trajectory

Perhaps the most closely watched element of the CBO forecast is its unemployment projection. The nonpartisan agency expects the jobless rate to peak at 4.6% in 2026—up from approximately 4.1% currently—before easing to 4.4% by 2028.

The forecast reflects a labor market that has cooled significantly from its post-pandemic tightness but remains healthy by historical standards. The current unemployment rate of 4.1% is well below the long-term average, and even the projected peak of 4.6% would represent a relatively mild softening.

"The labor market is normalizing after an extraordinary period of tightness. We expect unemployment to rise modestly as the economy adjusts to higher interest rates and reduced immigration flows, but the landing should be soft by historical standards."

— CBO economist, in report commentary

Several factors are expected to influence the unemployment trajectory:

• Immigration effects: Reduced migration flows limiting labor supply growth
• Monetary policy lags: Full impact of 2024-2025 rate hikes still materializing
• Tariff adjustments: Some sectors facing displacement from trade policy changes
• Fiscal stimulus: Tax cuts and spending partially offsetting headwinds

Inflation Remains Above Target

The CBO expects inflation to remain stubbornly above the Federal Reserve's 2% target in the near term, with the personal consumption expenditures (PCE) price index projected to average 2.5% in 2026 before gradually declining to 2.1% by 2028.

The persistent inflation reflects several factors, including the impact of tariffs on import prices, strong consumer demand supported by fiscal stimulus, and elevated shelter costs. The Fed's challenge will be balancing its inflation mandate against signs of labor market softening.

Notably, the CBO's inflation forecast assumes tariffs remain in place throughout the projection period. Some economists have argued that tariff-related price increases represent one-time level shifts rather than ongoing inflation, but the distinction matters less for consumers facing higher prices at the checkout counter.

Interest Rate Outlook

The report projects the federal funds rate declining from its current 4.25-4.50% range (midpoint 4.375%) to approximately 3.4% by late 2028. This path implies roughly 100 basis points of additional easing beyond current market expectations.

For the 10-year Treasury yield—the benchmark that influences mortgage rates—the CBO projects a gradual increase from 4.1% currently to 4.3% by late 2028. The projection suggests mortgage rates may remain elevated despite Fed rate cuts, as long-term yields reflect fiscal concerns and inflation expectations.

Treasury Secretary Bessent weighed in on the outlook Thursday, suggesting that Fed rate cuts are the "only ingredient missing" for a stronger economy. His comments reflect administration frustration with the Fed's cautious approach to easing.

GDP Growth Projections

Real GDP growth is projected at 2.2% for 2026, slightly below the economy's estimated potential growth rate of approximately 2.4%. The modest shortfall reflects the cumulative impact of tighter monetary policy, partially offset by fiscal stimulus from the tax legislation.

Key economic projections from the CBO:

• 2026 Real GDP growth: 2.2%
• 2027 Real GDP growth: 2.3%
• 2028 Real GDP growth: 2.4%
• Average unemployment 2026: 4.5%
• PCE inflation 2026: 2.5%
• 10-year Treasury yield 2028: 4.3%

Policy Implications

The CBO's projections carry significant implications for policy debates in Washington. The forecast assumes current law, meaning tariffs remain in place, immigration restrictions continue, and the tax provisions in the "One Big Beautiful Bill" proceed as enacted.

For Federal Reserve watchers, the projection reinforces expectations that the central bank will proceed cautiously with rate cuts. With inflation above target and the labor market still relatively healthy, the Fed has time to assess incoming data before accelerating the pace of easing.

President Trump has promised to appoint a new Fed chair before current chair Jerome Powell's term expires in May. The selection could influence the pace and magnitude of rate cuts, with some potential nominees favoring more aggressive easing than Powell has pursued.

Market Implications

For investors, the CBO outlook suggests a modest economic environment—not strong enough to fuel fears of overheating, but not weak enough to trigger recession concerns. This "Goldilocks" scenario has historically supported risk assets, though current valuations leave limited margin for disappointment.

Bond investors may face continued headwinds from elevated long-term yields. The CBO's projection of 10-year yields around 4.3% suggests current levels may persist, limiting capital appreciation potential while providing attractive income for patient investors.

Equity investors should note the employment trajectory. If unemployment does rise to 4.6%, consumer spending growth—the primary driver of U.S. economic activity—could moderate. Companies with discretionary exposure may face more challenging comparisons as the year progresses.

Friday's Jobs Report in Focus

The CBO release arrives just one day before the Bureau of Labor Statistics publishes December employment data—the first major economic release of 2026. Economists expect payroll gains of approximately 150,000 jobs, with the unemployment rate holding steady at 4.1%.

A significantly stronger or weaker report could shift expectations for Fed policy and pressure the CBO to revise its projections. For now, the nonpartisan agency has provided a useful baseline for understanding how the economy is likely to evolve under current policies.