Since the beginning of the month, a growing number of Federal Reserve officials have indicated that interest rate hikes may be necessary if inflation does not ease promptly. Concurrently, they have expressed skepticism about whether artificial intelligence (AI) can help curb inflation. This sets the stage for a potentially heated debate at the upcoming interest rate decision meeting in June, 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 price pressures from tariffs, fully permeate into core inflation?
"If I don't see inflation cooling over the next one or two quarters, I would be deeply concerned," stated St. Louis Fed President Alberto Musalem on Thursday at an economic conference co-hosted by the Central Bank of Iceland and Northwestern University. He outlined a scenario that could force the Fed to raise rates: "At this point, the balance of risks has clearly tilted towards 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 the phrasing that "the next step is most likely a rate cut" and replace it with "the likelihood of a rate hike or cut is equal." Musalem confirmed he is one of 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 heat up. Driven by soaring energy prices due to the US-Iran conflict, the US PCE price index rose 3.8% year-on-year in April, hitting a three-year high. Fed Governor Lisa Cook expressed similar views on Wednesday evening: "Maintaining rates at their current level 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 Fed Vice Chair and New York Fed President, John Williams, reiterated on Thursday that the current policy stance is appropriate. However, he added that if inflation remains persistently high, a rate hike would be inevitable.
Pricing in the federal funds rate futures market indicates that traders believe the Fed will not cut rates this year, with the probability of a hike nearing 50%. Traders are also fully pricing in a rate increase for the first quarter of next year.
The growing chorus of hawkish voices within the Fed may put Chair Warsh in a difficult position. A core expectation of his nomination by former President Trump was to facilitate rate cuts. In recent months, Warsh has hinted that he could support rate cuts if accompanied by balance sheet reduction and has suggested that AI could help lower inflation.
Some officials have offered a different perspective. Heavy corporate investment in chips and data centers to deploy AI could instead exacerbate inflation. "With real interest rates below the long-term 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 President Musalem.
A review 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 has also pushed up electricity prices in some regions, beginning to spill over into manufacturing and services.
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.
New York Fed President Williams concurred but noted that the market's understanding of accelerated productivity is not yet mature: "Based on evidence, market perception is gradual... Expectations for future productivity growth are slowly rising, and the increase in real interest rates will also lag." His statement did not offer a definitive judgment on "AI fighting inflation" but indicates the Fed is deeply studying this critical issue.
According to the schedule, the Fed will release its final policy statement of the first half of the year on June 17, marking Warsh's first public appearance as Chair. Recent public statements suggest that hawkish forces within the Fed are gaining the upper hand. They increasingly believe that the energy shock from the Strait of Hormuz is not a short-term disturbance that can be temporarily set aside but a significant risk that could damage the central bank's credibility.
For Chair Warsh, if he cannot lower the policy rate soon, he may soon face pressure from former President Trump. Angelo Kourkafas, Global Senior Investment Strategist at Edward Jones, stated, "The market's current focus is 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 artificial intelligence is another factor pushing inflation higher."
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