Vanguard Economists Say: Inflation Might Be Better Than It Looks. Here's Why That's Good News for Stocks.

Inflation has been hanging over the U.S. economy like a cloud. The latest Consumer Price Index (CPI) data for October 2026 found it increased by 0.4% last month, after rising 0.6% in September.

The current inflation data is nowhere near as bad as it was in 2022, when the inflation rate reached highs over 9%, but it's trending in the wrong direction. Many Americans are feeling pessimistic and worn out from stubbornly high costs of living.

Higher-for-longer inflation motivated the Federal Reserve to hike interest rates by 0.25% at its September meeting. The Fed is also widely expected to raise rates again at its next meeting on Dec. 9, with CME FedWatch forecasting a 90.8% chance of a 25-basis-point hike and a 9.2% chance of a 50-basis-point hike.

Higher interest rates can be bad for stock prices because they raise borrowing costs and reduce the supply of money that's available for investment and economic growth. But recent analysis from Vanguard offers reason for hope.

Let's look at why Vanguard is optimistic about inflation for 2027 -- and what it might mean for your investments.

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Vanguard: Core inflation could drop to 2.5% by April 2027

According to Vanguard, a major driver of inflation in 2026 was the Trump administration's new tariffs in 2025. But those tariffs were technically a one-time price increase; the tariffs don't keep going up every year. That means next year's inflation data might look more encouraging, because any increase in inflation will subtract from a higher base -- the 2026 inflation numbers that already included tariffs.

Vanguard forecasts that core inflation, as measured by the Personal Consumption Expenditures (PCE) price index, could drop to 2.5% by April 2027. That's close to the Fed's target of 2% and a meaningful improvement from today -- as of September 2026, core inflation was 3.6%.

And Vanguard says this downward move in inflation would come solely from the "tariff roll-off" effect. The tariffs haven't gone away, but they're no longer causing a year-over-year increase in inflation rates. They're already baked into the inflation levels.

If inflation goes lower in 2027, how should you invest today?

Vanguard forecasts a strong year for the U.S. economy in 2027, with 3% GDP growth, 4.4% unemployment, and core inflation of 2.5%. They expect the Fed to hike interest rates one more time in early 2027, bringing the effective federal funds rate to 4.4% (between 4.25% and 4.5%).

If Vanguard's analysis is correct, the U.S. economy could be in great shape in 2027. Inflation doesn't seem poised to become a big economic problem. The tariff effects might fade away. The Fed might not have to raise rates high enough to hurt the job market or cause significant declines in stock prices. The economy might stabilize in a way that's better for consumer prices and, ultimately, better for stock investors.

Vanguard's inflation research didn't make any specific recommendations about stocks or sectors to invest in. But if interest rates don't go much higher in 2027, that could be a bullish sign for tech exchange-traded funds (ETFs). Growth stocks can be more vulnerable to rising interest rates, because investors might move money into high-yield bonds and away from riskier stocks and richly valued sectors. But if inflation and interest rates remain steady or decline in 2027, that could be good news for tech stocks and the artificial intelligence (AI) trade.

The Invesco Nasdaq 100 ETF (NASDAQ:QQQM) lets you own 100 of the largest nonfinancial companies on the Nasdaq exchange. It charges a low expense ratio of 0.15%. This fund is similar to the popular Invesco QQQ Trust (NASDAQ:QQQ), known as "the Qs."

In the past five years (as of Oct. 31), QQQM has delivered annualized returns of about 13.1% -- including the 2022 bear market and the past few years of rising inflation and interest rates.

What if you're concerned that the AI trade is unsustainable, or you want to diversify and not put too much of your money into tech stocks? The Vanguard S&P 500 ETF (NYSEMKT:VOO) might also have a good year in 2027 if inflation and interest rates go in the right direction.

This S&P 500 ETF charges an ultra-low expense ratio of 0.03% and lets you own 500 of the largest publicly traded companies in America. There's some overlap with the stocks in the portfolios of VOO and QQQM. But the S&P 500 (SNPINDEX:^GSPC) is less tech-heavy and can put your money to work across a broader range of sectors. The Vanguard S&P 500 ETF has delivered annualized returns of about 12% in the past five years (as of Oct. 31).

No matter what happens in 2027 with inflation, interest rates, or the overall economy, investors need to focus on the long term. There's always uncertainty and doubt about the latest alarming news headlines. But in the long run, the stock market tends to deliver strong returns for investors who consistently buy stocks and hold them for many years.

Ben Gran has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.