Expectations of a Fed increase in December are strengthening, while AI investment is worsening the inflation outlook – potentially spelling bad news for mortgage rates
With just a month until the Federal Reserve’s final interest rate decision of 2026, last week’s October jobs report may have copper-fastened a December rate hike by the central bank.
Mortgage rates don’t rise and fall in line with Fed rate decisions, but bond markets often price in expectations of increases – meaning the Fed’s next moves could have big consequences on the rate outlook.
A Bureau of Labor Statistics report showed the labor market blew past expectations last month, adding 165,000 jobs as the unemployment rate ticked lower.
Those figures reflected an economy that’s still showing decent momentum despite global trade tensions and other geopolitical turbulence. But of most interest to the US central bank could be the fact that overall inflation is still outstripping hourly wage growth, rising by 3.7% at last reading compared with a 3.1% increase in wages.
Core PCE inflation, which excludes volatile food and energy categories, rose by 3.1% year over year in September.
Investment is also continuing to flood into artificial intelligence (AI), although last week’s midterm election result sparked speculation that a new Democrat-led Congress could curb the AI boom by introducing new guardrails and increased oversight of tech companies.
For now, though, a combination of factors – the impact of the US’s tariff regime, higher oil prices from the war in Iran, and AI investment – are likely to continue putting upward pressure on headline inflation, according to Oxford Economics’ chief US economist Michael Pearce.
“The two big [factors] are the pass-through of high energy prices, particularly diesel and gasoline prices, to a range of other consumer goods and services – in particular food prices – and the impact of the AI buildout, which is pushing up electronics prices, has put upward pressure on software prices as well,” Pearce said last week.
“We think those three shocks – the tariffs, AI buildout, and the knock-on impacts of energy prices – are adding as much as 0.8, 0.9 percentage points to core PCE inflation. If we’re thinking about core PCE inflation being 3.1%, almost all of that overshoot relative to the 2% target [is] driven by these supply shocks.”
Bond yield pressures could spell trouble for mortgage rates
Oxford Economics is forecasting national economic growth of 2.5% next year, Pearce said, with that likely to be spurred in large part by AI. “Our estimate is that something close to one-third of recent US GDP growth has been directly or indirectly driven by AI,” he said.
“That’s both just the physical capital investment in the technology, but also the rise in equity wealth, which we think is an important factor behind consumer spending as well.”
Oxford Economics and the Mortgage Bankers Association (MBA) both see a December Fed hike ahead, while prospects of a rate increase next month swelled to 84.5% on CME’s FedWatch, a gauge of market expectations for the central bank’s next moves.
Bernard Yaros, Oxford Economics’ deputy chief US economist, sees bond yields climbing further if AI spending continues at its current pace. That would likely mean mortgage rates, which move in tandem with bond yields, would also edge higher.
“The demand-side boost from greater spending will lead to stickier inflation, especially going into 2028, 2029,” he said. “And it also continued to put upward pressure on bond yields, especially 10-year yields.”
Don’t expect a big further drop in mortgage rates
There’s been at least some good news on the mortgage rate front in November, with the average 30-year fixed rate slipping to 7.18% last week – its third straight weekly decline. The 15-year fixed-rate mortgage, meanwhile, also ticked lower on a week-over-week basis.
But analysts also don’t see much room for further decline in average mortgage rates, likely hindering the outlook for the US housing market well into 2027.
Goldman Sachs Research economists Ronnie Walker and David Mericle expect existing home sales through all of next year to come in 26% below their 2019 level, with home price growth also facing a further slowdown.
That suggests another sluggish year could be in store for the mortgage market. “In 2027, we expect the headwind from affordability to increasingly dominate, weighing further on activity,” Walker and Mericle said.
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