As U.S. inflation accelerates once again, Federal Reserve officials have collectively delivered hawkish signals this week, further cementing market expectations for a December rate hike and opening the door to another increase in January.
San Francisco Fed President Mary Daly said Friday that the Fed will likely need to raise rates further, especially as services inflation trends remain worrisome and businesses find it increasingly difficult to absorb rising costs by compressing profit margins.
At the same time, the Fed's latest semi-annual financial stability report warned that an investment boom in artificial intelligence (AI) has pushed equity valuations to elevated levels, and that related returns and financing risks could pose a threat to financial stability.
U.S. October Consumer Price Index (CPI) data released this week showed not only signs of accelerating inflation but also a broadening in the range of price increases, spanning a variety of everyday goods and services. This has significantly raised the urgency for the Fed to tighten monetary policy further. Over the past three months, core CPI, which excludes volatile food and energy prices, has risen about 0.3% month over month, well above the 0.2% or lower monthly pace needed to achieve the Fed's 2% annual inflation target.
Speaking Friday at an economic forecasting event at the University of Nevada, Las Vegas, Daly said she currently leans toward the view that the Fed needs to raise its policy rate further, particularly given that services inflation is moving in the wrong direction and there are signs that inflationary pressures are persistent. "We will likely need to raise rates. I will discuss this with my colleagues at the December meeting and all future meetings, and together we will make the decision we deem most appropriate based on the evolving economic situation," she said. She noted that a growing number of producers report they no longer have much room to absorb higher costs by compressing margins, and are therefore considering passing higher costs on to consumers. That is precisely the kind of new inflationary pressure the Fed wants to avoid.
Like several other Fed officials, Daly is particularly concerned about services inflation excluding housing costs. Because this component tends to be highly sticky, once price increases become entrenched, it may be even harder to contain through monetary policy. Daly said that whether retailers or professional services firms, if they need to purchase more expensive information technology equipment, pay higher energy bills and face other rising input costs, they may choose to pass those costs on to customers, further pushing up services prices.
Daly's latest remarks further corroborate growing concerns within the Fed about the inflation outlook. New York Fed President John Williams said the current inflation level is "far too high" and the Fed still has work to do. Chicago Fed President Austan Goolsbee described the latest inflation data as "quite unsettling." Dallas Fed President Lorie Logan said the Fed may need to raise rates faster than she had previously expected, while Fed Governor Christopher Waller even suggested a 50-basis-point hike in December may be necessary.
Fitch Ratings U.S. economic research head Olu Sonola said: "A 25-basis-point hike in December is clearly largely a done deal. The real question is how soon the next hike comes, and how many more will ultimately be needed." This week, about half of the 19 Fed officials involved in Federal Open Market Committee (FOMC) policy discussions spoke publicly, including about half of those who will have voting rights at the December and January meetings. Although further rate hikes have become a broadly accepted policy direction among officials, there is still internal disagreement over the pace of increases and the eventual level of rates. In addition to Waller's openness to a single large hike, Cleveland Fed President Beth Hammack reiterated that she favors smaller but more frequent increases. Philadelphia Fed President Anna Paulson said a gradual tightening approach is more appropriate at present. Richmond Fed President Thomas Barkin also said rates need to rise further, but the pace should remain cautious.
Fresh economic data released Friday further intensified market worries about inflation. U.S. October producer prices rose at their fastest annual pace since 2022, with transportation and warehousing costs surging, further indicating that price pressures remain widespread in the U.S. economy. Because some producer price data feed into the Fed's preferred Personal Consumption Expenditures (PCE) price index, the latest figures also imply that future inflation readings may continue to face upward pressure.
Royal Bank of Canada U.S. economic research head Michael Reid said the Fed now appears increasingly worried about a re-acceleration in inflation and wants to get ahead of it by raising rates more frequently, and may even lift the terminal rate officials believe is needed for this tightening cycle. Influenced by the latest economic data and hawkish comments from Fed officials, several Wall Street institutions have raised their forecasts for the number of future rate hikes. Bank of America now expects the Fed to raise rates at three consecutive policy meetings, while Santander U.S. Capital Markets expects one hike in December and another in March.
Market expectations have also shifted markedly. Investors have now priced in 25-basis-point hikes in December, January and March, whereas before this week the market expected hikes only in December and March. If the Fed raises rates at both its December 8-9 meeting and its January 26-27 meeting, it would be the first time since 2023 that it has hiked at two consecutive policy meetings. The密集 remarks from Fed officials also triggered sharp swings in the U.S. Treasury market. On Tuesday, after hawkish speeches by Waller and Logan and stronger-than-expected inflation data, the two-year Treasury yield, which is sensitive to monetary policy changes, surged 19 basis points in a single day to 4.75%, the largest one-day increase since April 2025, when U.S. President Trump's tariff measures roiled global markets. Nationwide chief economist Kathy Bostjancic said the policy signals from Fed officials have been somewhat confusing and have caused large swings in Treasury yields. With Fed Chair Warsh not yet commenting on the near-term monetary policy outlook, remarks by other officials are filling that information gap.
Still, despite rising inflation pressures, some Fed officials remain concerned that further increases in borrowing costs could worsen difficulties in parts of the U.S. economy. The housing market is one example. Data released this week showed U.S. existing home sales in October fell to the lowest level in 16 years, highlighting the continued strain on housing under a high-rate environment. Boston Fed President Susan Collins acknowledged Friday that higher rates could further weaken housing affordability, but stressed that over the long run, price stability is more important for the housing market and the broader economy. She said the direction of further monetary tightening is clear, but she is not yet willing to judge how high rates should ultimately go or how fast they should rise.
Beyond housing, whether U.S. consumers can maintain spending amid persistently rising prices and borrowing costs is also an important factor for the Fed in assessing the future policy path. Daly said U.S. consumer spending has so far shown surprising resilience and has not yet fallen back markedly. However, with the year-end holiday shopping season approaching, she will closely watch consumer behavior over the next one to three months to gauge whether consumers will cut spending because of higher prices. Daly noted that in Las Vegas she has begun hearing feedback about weakening consumer spending momentum, and similar signs have appeared in other U.S. states, not just Nevada. Given that consumer spending accounts for the bulk of U.S. economic activity, if consumers begin to cut back noticeably, it could weigh on growth and complicate the Fed's rate-hike path.
At the same time, the Fed is also monitoring financial market risks that could arise from the AI investment boom, as well as how those risks interact with tighter monetary policy. The Fed's semi-annual financial stability report released Friday said pressures on U.S. asset valuations remain elevated, with equity valuations persistently high, partly due to market optimism about the future of AI technology. However, investor concerns about technology companies' massive capital expenditure and debt issuance plans have somewhat dampened that optimism. In recent years, as tech giants and AI startups invest heavily in data centers, chips and other computing infrastructure, the AI industry's financing model has drawn increasing attention. In particular, circular transaction arrangements, such as mutual investment between technology equipment suppliers and AI startups, equipment purchases and computing supply contracts, have raised concerns about investment returns and financing sustainability. Fed Vice Chair for Supervision Michelle Bowman warned earlier this week that if AI investment returns fall short of market expectations, stock prices could fall sharply and hit U.S. economic activity. Bowman noted that falling share prices could weaken the resilience of consumer spending, while higher rates could further intensify pressure on rate-sensitive sectors such as housing and small business investment.
The Fed's financial stability report also cited surveys of policymakers, community groups and financial market participants to assess potential risk events that could pose major threats to the financial system. Respondents believed that with the development of AI technology, the risk of cyberattacks on financial markets is rising. AI lowers the technical barriers for state and non-state actors to launch sophisticated cyberattacks, and the potential damage from AI models themselves also warrants attention. In addition, a pullback in risk asset prices, further increases in long-term interest rates and fiscal debt sustainability issues were also listed as factors that could threaten financial stability in the near term. The Fed stressed that the financial stability report is not a forecast of future economic or market trends, but rather aims to identify potential vulnerabilities in the financial system. At present, the Fed still faces the challenge of balancing inflation control with guarding against economic and financial risks. The central bank raised rates by 25 basis points in September, lifting the federal funds rate target range to 3.75%-4%, and then held rates steady at its October meeting. Fed Chair Warsh has not spoken publicly since the press conference after the October monetary policy meeting. He is scheduled to attend an event on AI and productivity next Monday, but markets widely expect he will maintain his stance of not providing clear guidance on the near-term monetary policy outlook.
Notably, the resilience of U.S. economic growth may give the Fed room to raise rates further. Data released last week showed U.S. job growth accelerated markedly in October and the unemployment rate edged down. Before the December monetary policy meeting, the Fed will also receive a new employment report and another reading on October inflation. PGIM chief U.S. economist Robert Sockin argued that in an environment of strong growth and high inflation, a gradual rate-hike strategy may be a policy mistake. Historical experience shows that if a central bank fails to act forcefully enough to curb inflation in time, it may ultimately have to tighten policy faster and more aggressively.
Comments