Countervailing forces will soften economic dip, UCLA Anderson predicts

Opposing forces will cause the U.S. and California economies to soften in early 2026 before strengthening later in the year, UCLA Anderson Forecast economists predicted in their December outlook.

Nationally, massive artificial intelligence infrastructure investment — originally estimated at $250 billion by technology analysts — has already surpassed $405 billion with more to come next year, Clement Bohr, a forecast senior economist, said in his report. That — combined with income growth for high-wealth households — is being offset by tariff-induced inflation, policy uncertainty and a weakening labor market, Bohr added. The economy will “muddle through” early 2026, he said.

With any artificial-intelligence-driven productivity growth still years away, the core question is whether AI growth or tariff-induced inflation will ultimately prevail, Bohr said.

Tariffs are continuing to affect supply chains, raising goods prices and placing pressure on consumers and small businesses, Bohr said. The ongoing policy uncertainty, including anticipated U.S. Supreme Court decisions on tariff authority, has made long-term planning difficult for firms and contributed to a cautious hiring environment, he said.

“Consumption by higher-income households has been boosted by large AI-driven financial wealth gains and they are unlikely to see gains of the same magnitude going forward,” Bohr said.

The current AI boom will eventually be tempered by several critical constraints, particularly concerning electricity production and grid capacity, Bohr said.

Bohr warned however that an era of elevated uncertainty persists regarding the economy, because federal policy continues to fluctuate and the historically long shutdown left economists partially blind as to how the economy was unfolding during the fall. The range of opposing forces also “implies a greater scope for the forecast to miss in either direction,” Bohr said.

In California, AI, aerospace and other high-productivity sectors are pushing its economy ahead of the national outlook, but it also faces challenges in the construction, non-durable goods, leisure and hospitality and the government-funded sectors, said Jerry Nicklesburg, senior economist and director emeritus for the UCLA Anderson Forecast, in his report.

An analysis by the economists of past instances of immigration restrictions suggests deportations tend to raise unemployment among U.S.-born and documented workers as consumption slows and disruptions occur. County-level data in the state show this pattern emerging, especially in counties with higher concentrations of foreign-born workers employed in agriculture, construction and hospitality.

“We are beginning to see the impact of deportations on the unemployment rate,” Nickelsburg said. “Agriculture and leisure and hospitality are likely affected by the administration’s directive for ICE to avoid farms, hotels, and restaurants.”

Preliminary results indicate the impact of deportations on those with legal status will be uneven across California’s counties, Nicklesburg said. “The rapid reduction in the unemployment rate that has been characteristic historically, and which was built into our recent forecasts, is likely to be too optimistic. Consequently, we have adjusted the reduction in the unemployment rate in the current forecast.”

Over the first eight months of the year, the state lost payroll jobs and the unemployment rate increased to 5.5%, Nickelsburg said.

The Anderson economists aren’t predicting a sharp slowdown, as the nation and state “muddle through,” in early 2026 and gain strength late in the year that will carry through to 2027.

Employment growth, however, has slowed sharply and unemployment is expected to inch up to 4.5% by the end of 2025, according to the forecast. Inflation is expected to peak at 3.5% in early 2026, driven largely by pass-through from earlier tariff hikes, before gradually declining, but remaining above target.

Interest rates have stabilized and long-term rates are expected to remain in the 4% to 4.4% range, as structural pressures including elevated public deficits, aging demographics and heavy borrowing linked to AI investments prevent a return to pre-pandemic norms, Bohr said.

Overall GDP growth will soften in late 2025 and early 2026, exacerbated by temporary effects from the record-setting 43-day federal government shutdown. Fiscal and monetary stimuli included in House Resolution 1 are expected to spur the late 2026 recovery, Bohr said.