The United States faces the risk of re-inflation under demand expansion

Recently, some international organizations have provided forecasts for the growth rate of the U.S. economy, indicating that the growth rate in 2026 will remain stable compared to 2025, with a slight increase. For example, on October 14, 2025, the International Monetary Fund (IMF) in its "World Economic Outlook" projected that the U.S. GDP growth rates for 2025 and 2026 would be 2.0% and 2.1%, respectively. This is mainly influenced by adverse factors such as economic policy uncertainty, increased trade barriers, and a slowing job market.

However, we believe that the U.S. economy in 2026 has five favorable factors from the demand side, and the drag effect of tariffs may also be lower than expected, potentially achieving a higher growth rate under baseline scenarios. Nevertheless, these five favorable factors all stem from fiscal, monetary, exchange rate, and investment demand factors, and the combined effect of these forces will also lead to a significant increase in re-inflation risks. This will have certain implications for the Federal Reserve's monetary policy and the 2026 U.S. midterm elections.

1 Expansion of Demand in Five Areas

First, fiscal policy is beginning to accelerate. On November 12, local time, U.S. President Trump signed the "Continuing Appropriations and Extensions Act" at the White House, officially ending a government "shutdown" that lasted for more than 40 days. The longest government "shutdown" in history undoubtedly brought a huge negative impact on the U.S. economy, and after the funding agreement was passed, U.S. fiscal spending will accelerate. As early as July 4, Trump signed the $4.5 trillion tax cut and spending bill known as the "Tax Cuts and Jobs Act." According to estimates from the Congressional Budget Office (CBO), the "Tax Cuts and Jobs Act" will bring about $480 billion in additional fiscal spending in 2026, compared to only $170 billion in 2025. The U.S. fiscal deficit for the 2026 fiscal year is expected to reach approximately $2.2 trillion, with the deficit rate rising to about 7%, higher than the $1.8 trillion and 5.9% for the 2025 fiscal year. Moreover, due to the increase in tariff levels, U.S. tariff revenue is expected to rise from $77 billion in the 2024 fiscal year to $195 billion in the 2025 fiscal year, and is projected to approach $300 billion in the 2026 fiscal year. The increase in fiscal revenue from tariffs also provides more support for expanding fiscal spending in the U.S. in 2026.

Second, the Federal Reserve has entered a rate-cutting cycle, with a loose monetary policy. The Federal Reserve restarted its rate-cutting cycle in the third quarter, cutting rates by 25 basis points in September and November, bringing the federal funds rate target range down to 3.75-4.0%, with further cuts expected in December. The stimulating effect of continued rate cuts on the economy will gradually become apparent in 2026. At the same time, the Federal Reserve is expected to continue cutting rates under baseline scenarios in 2026. On one hand, the Federal Reserve has raised its tolerance for inflation. With core PCE still close to 3%, the Federal Reserve chose to cut rates in September and November, indicating that the inflation threshold for rate cuts has increased. On the other hand, the political pressure facing the Federal Reserve is growing, with Trump repeatedly pressuring the Fed to cut rates. On August 2, Federal Reserve Governor Adriana Kugler unexpectedly resigned, and Trump immediately announced the nomination of Stephen Moore, chairman of the White House Council of Economic Advisers, to fill this vacancy Milan is a staunch "MAGA" faction; subsequently, Trump also attempted to remove Federal Reserve Governor Lisa Cook from her position to push for accelerated interest rate cuts by the Federal Reserve. By May 2026, the current Federal Reserve Chairman Jerome Powell's term will end, and Trump will be able to nominate a new Federal Reserve Chairman. These personnel changes and political pressures will undoubtedly increase the likelihood of the Federal Reserve continuing to cut interest rates in 2026. The dot plot from the Federal Reserve in September and the predictions from the Chicago Mercantile Exchange's "Fedwatch" indicate that interest rates will continue to be cut by 50-75 basis points in 2026, bringing the federal funds rate down to around 3%. A 3% interest rate level will further approach the neutral rate, significantly weakening its restrictive effect on the economy, and sectors sensitive to interest rates, such as real estate and manufacturing, are expected to shake off the relatively sluggish situation of 2025.

Third, the US dollar index is generally in a weak cycle. Since 2025, the US dollar index (DXY) has significantly weakened, especially with a notable decline in the first half of the year, dropping from 109 at the beginning of the year to a low of 96.6 in July, marking a three-year low with a decline of over 11%. This is mainly influenced by the reciprocal tariff policies introduced by the Trump administration. Since the second half of the year, although the dollar index has rebounded somewhat, it still fluctuates below 100, with an overall depreciation of over 8%. Against the backdrop of the Federal Reserve entering a rate-cutting cycle, the dollar index is likely to remain low in 2026. Moreover, recent studies suggest that the decline in the dollar index may not be a short-term adjustment but rather the beginning of a longer downward cycle (Miao Yanliang, 2025). A weak dollar helps alleviate the negative impact of high tariffs on the US economy, providing support for the US economy in 2026.

Fourth, the investment boom in artificial intelligence. In 2025, the United States entered a prosperous investment cycle in the artificial intelligence (AI) industry. US companies are experiencing explosive growth in AI-related spending, with capital investments from just Microsoft, Google, Amazon, and Meta expected to reach a record $364 billion in 2025. The AI boom has not only driven astonishing investments in infrastructure such as data centers and increased energy demand but has also led to record highs in the US stock market, with the resulting wealth effect indirectly promoting steady growth in US consumption. According to estimates from Bank of America Global Research, AI-related investments contributed 1.2 percentage points to US economic growth in the first quarter, with the contribution further rising to 1.3 percentage points in the second quarter, helping the US economy achieve a strong rebound after a weak performance at the beginning of the year. However, recent concerns about a potential AI bubble in the US have begun to increase significantly, as current AI investments have not yet yielded obvious returns. Nevertheless, in the short term, the investment boom in the AI industry continues, especially in an environment where the Federal Reserve has begun to cut interest rates, leading to heightened enthusiasm in the capital markets. From the perspective of industrial development, the growth of the AI industry and the construction of infrastructure such as data centers are still in the early stages. Under the baseline scenario, the ongoing investment boom in artificial intelligence will also become an important driving force for US economic growth in 2026 Fifth, the preliminary fulfillment of investment and procurement commitments from countries such as Europe, Japan, and South Korea. In trade negotiations with various countries, Trump has forced other nations to accept high investment commitments to the U.S. in exchange for tariff reductions. For example, the trade agreement between Japan and the U.S. includes a $550 billion investment commitment to the U.S., covering a total of 21 strategic projects in multiple fields such as energy, critical minerals, and AI, with participating companies including SoftBank Group, Mitsubishi Heavy Industries, and Toshiba, which need to be completed by January 19, 2029, the day before Trump's term ends. In the trade agreement with the U.S., the European Union not only committed to purchasing $750 billion worth of energy products such as liquefied natural gas, oil, and nuclear energy from the U.S., significantly increasing military and defense equipment procurement from the U.S.; European companies will also invest an additional $600 billion in strategic areas in the U.S. South Korea has committed to providing $350 billion to the U.S. for investment projects owned and controlled by the U.S., with cash investments accounting for $200 billion and an annual investment cap of $20 billion, with profits split evenly between the U.S. and South Korea. As early as Trump's Middle East trip in May 2025, Saudi Arabia, Qatar, and the UAE also made commitments for substantial investments in the U.S., with the UAE announcing a $1.4 trillion investment plan over the next ten years.

Trump himself has recently claimed that he has brought a total of $18 trillion in investments to the U.S. This is certainly highly exaggerated, and in fact, many investments are difficult to realize. However, as a starting year, there is a high likelihood that a small portion of investments will begin to materialize in 2026. Therefore, considering the enormous procurement and investment commitments from various countries, even if a small portion of these materializes in 2026, it will contribute to supporting U.S. economic growth.

2 The negative impact of tariffs on U.S. economic growth may be lower than expected

The impact of high tariffs on the U.S. economy is a major concern for organizations like the IMF, which worry it will drag down U.S. economic growth in 2026. Due to the impacts of "fentanyl tariffs," "reciprocal tariffs," and "Section 232 industry tariffs," the level of tariffs in the U.S. significantly increased at the beginning of 2025. A report from Yale University's Budget Lab shows that the average effective tariff rate in the U.S. has risen from 2.4% at the beginning of 2025 to 16.8% by the end of the year, reaching the highest level since 1934. In the first quarter, the year-on-year growth rate of U.S. imports surged to 41.3%, with net imports dragging down first-quarter GDP by nearly 4.7 percentage points, which was a significant factor contributing to the economic weakness at the beginning of the year. However, as the import rush effect diminished in the second and third quarters, the impact of tariffs on the U.S. economy has become less significant entering the third quarter.

Currently, the likelihood of the U.S. tariff level continuing to rise significantly in 2026 is low. Although "Section 232 industry tariffs" may continue to be implemented, their impact on the overall tariff level in the U.S. is not substantial; after the Kuala Lumpur talks at the end of October, both China and the U.S. agreed to suspend the 24% reciprocal tariffs for one year, and the U.S. will also reduce the fentanyl tariff on China from 20% to 10%; during the hearing held by the U.S. Supreme Court on November 5, most judges questioned whether the International Emergency Economic Powers Act grants the president the authority to impose large-scale tariffs, believing that the power to levy taxes is a core power of Congress The Supreme Court may issue a ruling unfavorable to Trump in 2026, and there is a possibility that the existing reciprocal tariffs could be suspended or even revoked.

The constraints of high tariffs on the U.S. economy will continue to weaken by 2026. On one hand, the uncertainty surrounding tariffs has significantly decreased. Uncertainty is a factor that affects U.S. economic growth more than the tariffs themselves. In 2025, Trump has already pushed for preliminary trade agreements with major partners such as the UK, Japan, the EU, South Korea, Vietnam, and Indonesia, entering a rare pause in economic and trade friction with China. The policy uncertainty faced by both import and export trade and investment in the U.S. has significantly decreased. Notably, the U.S. Economic Policy Uncertainty Index jointly released by Stanford University and the University of Chicago has returned to levels seen before Trump took office.

On the other hand, the current level of tariffs does not have a completely negative impact on the U.S. economy. High tariffs undoubtedly impose a heavy burden on importers, exporters, and consumers, partially driving up inflation levels. However, apart from China, other economies have not implemented substantial countermeasures against the U.S. "reciprocal tariffs," which greatly reduces the impact of increased tariffs on the U.S. economy itself. A recent study by the Chicago Federal Reserve pointed out that in the absence of countermeasures from other countries against U.S. tariffs, the optimal external tariff rate for the U.S. in the short term is 19.7%, and tariffs would have a positive pull of 0.3% on U.S. GDP (Caydn Hillier et al., 2025). The 2014 Handbook of International Economics also suggested that the optimal external tariff rate for the U.S. is 20%. Based on this, the current tariff level in the U.S. is still at a "reasonable" level for the U.S., and in the short term, it still has a certain stimulating effect on the U.S. economy. As long as tariffs do not continue to rise significantly in 2026, they will not become a major constraint on economic growth.

3 The Risk of Re-inflation Facing the U.S. in 2026

While five positive factors on the demand side may stimulate the U.S. economy to achieve higher growth, they also exacerbate the risk of uncontrolled inflation in the U.S. Since April 2025, both the CPI and core CPI in the U.S. have continued to rise, reaching 3% in September, indicating ongoing inflationary pressure. The continued expansion of demand, especially further easing of fiscal and monetary policies, will put greater pressure on inflation. Although the inflation impact from tariffs is lagging, it will eventually become apparent. In 2025, the impact of high tariffs on the U.S. was largely absorbed by import enterprises through squeezing profit margins. However, recent surveys show that import enterprises are planning to pass on a larger proportion of costs to consumers. At the same time, due to the lagging nature of the tariff inflation effect, its impact may be more persistent than expected, rather than "one-time." Data shows that the one-year inflation expectation from the University of Michigan has dropped from 6.6% in May to 4.6% in October; the one-year inflation expectation from the New York Federal Reserve's consumer survey also remains at 3.2%. These two figures have either decreased or maintained at a certain level, but are significantly higher than the Federal Reserve's average inflation target. The risk of uncontrolled inflation in the U.S. in 2026 cannot be ignored Conversely, renewed inflation or inflation expectations could become a suppressive factor for U.S. economic growth in 2026. Although the Federal Reserve has increased its tolerance for inflation, it is not limitless. If a 3% inflation level persists for an extended period, or if inflation rises to 3.5% or higher, even under pressure from Trump, the Federal Reserve may have to shift towards tightening; otherwise, inflation expectations could spiral further out of control. This unexpected shift in monetary policy would also bring about a series of chain reactions. Currently, U.S. stock valuations are at historical highs, and marginal changes in monetary policy expectations could trigger valuation adjustments, impacting not only the already fragile AI investment wave but also the enthusiasm of international investors.

Overall, due to significant demand expansion and a reduction in tariff shocks, the baseline scenario for the U.S. economy in 2026 is expected to show high growth and high inflation. I estimate that the growth rate could reach around 2.5%, higher than general market expectations. However, correspondingly, inflation may also rise to a high level of 3%-3.5%. The path of the Federal Reserve's monetary policy easing will face more challenges. In a re-inflation context, if the pressure on monetary policy becomes too great and there is no clear direction, the U.S. economy may also fail to achieve 2.5% growth.

In 2026, Trump and the Republican Party will also face the test of midterm elections. Recent polls conducted by Reuters and Ipsos show that Trump's approval rating has dropped to a record low of 40% during his current term; the Republican Party lost consecutive gubernatorial elections in Virginia and New Jersey in early November, and the Democrats defeated the independent candidate supported by Trump in the New York City mayoral race. The New York Times believes that the high cost of living is a major factor leading to political "losses" for Trump and the Republican Party. If inflation in the U.S. remains above 3% in 2026, Trump and the Republican Party may face a "Waterloo" in the midterm elections, losing the majority in the Senate or House of Representatives, or even both chambers. Higher economic growth cannot offset voters' dissatisfaction with high prices, as evidenced by Biden and the Democrats losing the 2024 election.

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