This month, a growing number of Federal Reserve officials have indicated that interest rate hikes may be necessary if inflation does not subside quickly. Concurrently, they have expressed skepticism about whether artificial intelligence (AI) can effectively curb inflation. This sets the stage for a potentially heated debate at the upcoming rate decision meeting next month, the first to be chaired by new Fed Chair Kevin Warsh.
Inflationary pressures continue to intensify. Since the outbreak of the US-Iran conflict, a sharp surge in gasoline and fuel prices has sparked intense debate among Fed officials: will energy price increases, combined with tariff-driven cost pressures, fully permeate into core inflation?
"If we don't see inflation cooling over the next one or two quarters, I would be very concerned," said St. Louis Fed President Alberto Musalem on Thursday at an economic conference jointly hosted by the Central Bank of Iceland and Northwestern University. He outlined a scenario that could force the Fed to raise rates: "Right now, the balance of risks is clearly tilted toward inflation, not the labor market."
The latest meeting minutes reveal that at least six of the 19 Fed officials last month believed the post-meeting statement should remove language suggesting "the next move is likely a rate cut," replacing it with wording indicating "the likelihood of rate hikes and cuts is roughly balanced." Musalem confirmed he was among them: "I am concerned that inflation will not fall back to the 2% target as expected."
These remarks come as US price pressures continue to build. Influenced by soaring energy prices due to the US-Iran conflict, the US PCE price index rose 3.8% year-over-year in April, hitting a three-year high. Fed Governor Lisa Cook expressed a similar view on Wednesday evening: "Maintaining rates at current levels is appropriate for now, but if inflation does not decline as expected and in a timely manner, I am prepared to support a rate hike."
Notably, the influential New York Fed President John Williams also reiterated on Thursday that the current policy stance is appropriate, but if inflation remains persistently high, a rate hike will become inevitable.
Pricing in federal funds rate futures shows the market believes the Fed will not cut rates this year, with the probability of a hike nearing 50%. Traders are fully pricing in a rate increase for the first quarter of next year.
The increasingly hawkish voices within the Fed may place Warsh in a difficult position. Former President Trump nominated him for the chairmanship with a core expectation of pushing for rate cuts. In recent months, Warsh has hinted he could support a rate cut if paired with balance sheet reduction and has suggested AI could help lower inflation.
Some officials have offered a different perspective. Significant corporate investments in chips and data centers to deploy AI could instead exacerbate inflation. "With real interest rates below the long-run neutral level, inflation significantly above target, long-term inflation expectations rising, and a stable labor market, relying on future productivity gains to solve current inflation problems is extremely risky," emphasized Musalem.
An analysis finds that global AI giants, including Amazon, Microsoft, Google, and Meta, have capital expenditures exceeding $600 billion this year. This has driven up prices for GPUs, AI accelerator chips, and memory (DRAM). Data center demand is pushing up electricity prices in some regions, beginning to transmit into manufacturing and services sectors.
Chicago Fed President Austan Goolsbee takes the argument further: if the market widely expects AI to boost productivity, consumers might engage in significant spending in anticipation of future wealth increases, leading to an overheated economy and forcing the Fed to raise rates.
The New York Fed President agreed with this point but noted that market understanding of accelerating productivity is still immature: "Based on evidence, market cognition is gradual... expectations for future productivity growth rise slowly, and the increase in real interest rates also lags."
His comments did not offer a definitive judgment on AI's ultimate role in fighting inflation but indicate the Fed is deeply studying this critical issue.
According to the schedule, the Fed will release its final policy statement for the first half of the year on June 17, marking Warsh's first public appearance as chair. Based on recent public statements, hawkish forces within the Fed are gaining the upper hand. They increasingly believe that energy shocks from the Strait of Hormuz are not a short-term disturbance that can be temporarily set aside, but a significant risk that could damage the central bank's credibility. For Warsh, if he cannot lower policy rates soon, he may soon face pressure from former President Trump.
"Current market focus is concentrated on the geopolitical situation and progress in peace talks. Oil prices continue to influence inflation expectations. At present, consumer spending remains resilient, and the investment boom in the artificial intelligence sector is also one of the factors pushing inflation higher," said Angelo Kourkafas, Global Senior Investment Strategist at Edward Jones.
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