Inflation Pressures Persist, Fed Rate Hike Expectations Intensify, AI Investment Risks Increase Financial Stability Concerns

According to Zhitong Finance APP, with U.S. inflation accelerating again, Federal Reserve officials have intensively released hawkish signals this week, further reinforcing market expectations for a rate hike in December and opening the door to another hike in January next year. San Francisco Fed President Daly said on Friday that the Fed will likely need to raise rates further, especially amid worrying inflation trends in the services sector and businesses finding it increasingly difficult to absorb rising costs by compressing profit margins. Meanwhile, the Fed's latest semi-annual Financial Stability Report warned that the AI investment boom is keeping stock valuations high, and that the associated investment returns and financing risks may pose threats to financial stability.

U.S. October Consumer Price Index (CPI) data released this week showed not only signs of accelerating inflation, but also a broader scope of price increases, affecting a variety of everyday goods and services. This has clearly heightened the urgency for the Fed to further tighten monetary policy.

In the past three months, the core CPI, which excludes the more volatile food and energy prices, has risen by about 0.3% on a month-on-month basis—significantly higher than the 0.2% or lower monthly increase needed to achieve the Fed's 2% annual inflation target.

Speaking at an economic forecast event at the University of Nevada, Las Vegas on Friday, Daly said she currently leans toward the Fed needing to further raise policy rates, especially considering that services inflation is moving in the wrong direction and there are already 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 at all future meetings, making what we believe to be the most appropriate decision based on constantly changing economic conditions."

She pointed out that more and more producers are reporting they have little room left to absorb rising costs by compressing profit margins, and are therefore considering passing these higher costs on to consumers. This is precisely the new round of inflationary pressure the Fed hopes to avoid.

Like several other Fed officials, Daly is particularly concerned about services inflation excluding housing costs, as this type of inflation tends to be sticky and, once entrenched, may be more difficult to curb with monetary policy.

Daly noted that whether it’s retailers or professional service firms, if they need to purchase higher-priced IT equipment, pay higher energy costs, and face other rising input expenses, they may choose to pass these costs on to customers, further driving up service prices.

Daly's latest remarks further confirm the growing concern within the Fed about the inflation outlook.

New York Fed President Williams said that the current level of inflation is "far too high," and that the Fed still has work to do. Chicago Fed President Goolsbee described the latest inflation figures as "quite concerning," while Dallas Fed President Logan said the Fed may need to raise rates faster than she previously expected. Fed Governor Waller even suggested that a 50-basis-point hike in December might be necessary.

Olu Sonola, head of U.S. economic research at Fitch Ratings, commented: “A 25-basis-point hike in December increasingly seems like a done deal. The real question is how soon the next rate hike will come, and how many more hikes will ultimately be needed.”

This week, among the 19 Fed officials participating in the FOMC policy discussions, about half gave public speeches, including about half of those who will have voting rights at the December and January meetings. Although further rate hikes have become the consensus policy direction among officials, there are still internal divergences regarding the pace and the eventual level of interest rates.

Apart from Waller’s openness to a larger single hike, Cleveland Fed President Mester reiterated her preference for smaller but more frequent rate increases. Philadelphia Fed President Harker believes a more gradual approach to policy tightening is appropriate for now. Richmond Fed President Barkin also indicated that while rates need to go higher, the pace of hikes should be cautious.

The latest economic data released on Friday has further intensified market concerns about inflation. U.S. producer prices for October rose at the fastest pace since 2022, with transport and warehousing costs surging, further indicating that price pressures remain widespread throughout the U.S. economy.

Since some producer price data is used to calculate the Fed’s preferred Personal Consumption Expenditures (PCE) Price Index, the latest figures also suggest that inflation indicators may continue to face upward pressure going forward.

Michael Reid, head of U.S. economic research at RBC, said the Fed increasingly appears concerned that inflation may reaccelerate and wants to counteract it by hiking rates more frequently—potentially even raising the peak rate needed in the current tightening cycle.

Under the influence of the latest data and hawkish Fed comments, several Wall Street institutions have raised their forecasts on the number of future rate hikes. Bank of America now expects the Fed to raise rates at each of the next three monetary policy meetings; Santander U.S. Capital Markets expects hikes in December and again in March next year.

Market expectations have also shifted notably. Investors have now priced in 25-basis-point hikes from the Fed in December, January, and March, whereas before this week, the market only expected hikes in December and March.

If the Fed raises rates at both the December 8–9 and January 26–27 policy meetings, it would be the first time since 2023 that hikes have occurred in two consecutive meetings.

The flurry of statements by Fed officials has also sparked volatility in the U.S. Treasury market. On Tuesday, after hawkish speeches by Waller and Logan and hotter-than-expected inflation data, the yield on the 2-year U.S. Treasury—which is sensitive to policy changes—jumped by 19 basis points to 4.75% in a single day, marking its largest one-day gain since April 2025, when global markets were shaken by U.S. President Trump’s announced tariff measures.

Kathy Bostjancic, chief economist at Nationwide, said the policy signals sent by the Fed officials seem somewhat chaotic and have triggered sharp moves in Treasury yields. In the absence of recent public commentary from Fed Chair Powell on monetary policy, other officials’ speeches are filling that information gap.

However, even as inflation pressures build, some Fed officials remain concerned that further increases in borrowing costs could exacerbate difficulties in parts of the U.S. economy, with the real estate market being a case in point. Data this week showed existing home sales in the U.S. fell in October to their lowest level in 16 years, highlighting the continuing strain on real estate under high interest rates.

Boston Fed President Collins acknowledged on Friday that higher rates could further erode housing affordability, but she also emphasized that, in the long run, price stability is more important for both the real estate market and the broader economy. She said the need to further tighten current policy is clear, but she is not yet ready to judge how high rates should eventually go or how quickly they should get there.

Aside from real estate, a key factor for the Fed in planning future policy is whether U.S. consumers can maintain spending against a backdrop of persistent increases in prices and borrowing costs.

Daly said that U.S. consumer spending has shown unexpected resilience so far and has not declined significantly. However, with the holiday shopping season approaching, she will closely monitor consumption over the next one to three months to determine if higher prices start to cut into spending.

Daly pointed out that feedback is already emerging in Las Vegas about weaker consumer spending, and similar signs are appearing in other states besides Nevada.

Given that consumer spending accounts for a large portion of U.S. economic activity, if consumer outlays noticeably begin to decline in the coming months, economic growth could be affected, creating further considerations for the Fed’s rate hike path.

At the same time, the Fed is also watching potential financial market risks brought by the boom in AI investment and the interplay between such risks and monetary tightening. According to the semi-annual Financial Stability Report released on Friday, valuation pressures in U.S. assets remain high, with stock valuations elevated in part due to market optimism about AI technology development. Nevertheless, investor concerns about the massive capital expenditures and debt issuance plans of tech companies have somewhat dampened this optimism.

In recent years, as tech giants and AI startups poured investments into data centers, chips, and other computing infrastructure, the financing models of the AI industry have come under increasing scrutiny. In particular, circular transactions involving mutual investments, equipment purchases, and computing supply contracts between tech equipment suppliers and AI startups have sparked concerns about the sustainability of related investment returns and financing.

Fed Vice Chair for Supervision Bowman warned earlier this week that if AI investment returns fall short of market expectations, stock prices could see sharp declines and the U.S. economy could be impacted. Bowman noted that falling stock prices may weaken the resilience of consumer spending and that higher rates could further pressure interest-rate sensitive sectors such as real estate and small business investment.

The Fed’s Financial Stability Report also cited survey results from policymakers, community groups, and financial market participants to assess risk events that could pose major threats to the financial system in the future.

Respondents believe that as AI technology develops, the risk of financial markets being hit by cyberattacks is rising. AI lowers the technical barriers for both state and non-state actors to launch sophisticated cyberattacks, and the risks AI models themselves pose deserve attention. In addition, abrupt corrections in risk asset prices, further rises in long-term interest rates, and the sustainability of fiscal debt were also listed as factors that could threaten financial stability in the short term.

The Fed emphasized that the Financial Stability Report is not a prediction of future economic or market trends, but aims to identify potential vulnerabilities the financial system may face.

Currently, the Fed still faces the challenge of balancing the need to curb inflation with the need to prevent economic and financial risks. In September, the central bank raised rates by 25 basis points, moving the federal funds rate target range up to 3.75%–4%, and then kept rates unchanged at its October meeting.

Fed Chair Powell has not spoken publicly since the press briefing following the October policy meeting. He’s scheduled to attend an event on AI and productivity next Monday, but the market generally expects he will maintain his stance of not providing clear guidance on the near-term monetary policy outlook.

It’s worth noting that the resilience of the U.S. economy may provide the Fed with scope for further rate hikes. Data released last week showed U.S. job growth accelerated significantly in October, and the unemployment rate declined slightly. Before the December policy meeting, the Fed will also receive a new jobs report and another data point reflecting October inflation.

PGIM Chief U.S. Economist Robert Sockin believes that in an environment of strong economic growth and high inflation, a gradual rate hike strategy could be a policy mistake. Historical experience shows that if a central bank fails to act quickly and strongly enough to suppress inflation, it may eventually be forced to tighten policy at a faster and larger pace.