The AI boom has become a new variable in policy uncertainty.

Written by: Yang Chen, Wall Street Journal

Two Federal Reserve officials have successively issued hawkish signals, emphasizing that inflation pressures are persistent and the direction of monetary policy tightening is clear, but the pace of execution still requires careful consideration.

Richmond Fed President Tom Barkin stated on Monday that strong demand and persistently high inflation mean that interest rates still need to rise further, but he simultaneously warned that any rate hikes must proceed cautiously. This statement aligns with the recent positions of several Fed officials.

On the consumption side, Barkin pointed out that corporate earnings have performed well, and consumer spending remains resilient, with the economy experiencing a historic record of unemployment rates staying at 4.5% or below. However, he also raised questions about whether this strength can be sustained, noting that both businesses and households continue to reflect cost pressure, leaving uncertainty in the inflation outlook.

Notably, Barkin referred to the AI boom as the "elephant in the room" that policymakers must address, believing its trajectory will have a profound impact on the economy in the near term.

Chicago Fed President Austan Goolsbee also noted on the same day that inflation in the service sector has clearly accelerated in recent months, exceeding the explanations offered by tariff pressures. He stated that employment and growth are relatively stable, emphasizing that the Federal Reserve must confront the issue of "out-of-control inflation."

The consumer price index (CPI) for October, to be released on Tuesday, along with subsequent employment reports, will be critical data references before the Fed's decision in December. Currently, market traders estimate the probability of a Fed rate hike in December to be around 80%.

The direction of interest rate hikes is clear, but the pace must remain cautious

Barkin stated in a speech in South Carolina, "The appropriate direction for monetary policy is relatively clear, but the risks faced by the demand outlook are not hard to imagine; therefore, it is wise to advance policies cautiously."

Last month, the Federal Reserve decided to hold steady with a vote of 10 to 2, having unanimously agreed in September to raise the benchmark interest rate by 25 basis points to a target range of 3.75% to 4%. Officials at that meeting indicated that "accumulating more information" would aid in determining the best level for policy.

Since that meeting, several officials have publicly emphasized the necessity of further rate hikes. Data released last week showed a significant increase in non-farm payrolls in October, with a slight decline in the unemployment rate, further supporting the hawkish stance.

Before the December meeting, Fed officials will also see at least one employment report and a series of inflation data, with the first data being the October CPI released on Tuesday.

Resilience of consumption is in question, cost-pass-through pressure is rising

Barkin holds a cautiously optimistic view of the consumer outlook, expecting that consumer spending will remain resilient by the end of this year, but he attached explicit caveats to this judgment. "The holiday shopping season is generally expected to be strong, but how long consumers can maintain this strength is still a question," he said.

In discussions with reporters after the meeting, Barkin expressed concern about the transmission risks of corporate cost pressures.

He pointed out that businesses are currently facing "broad cost" pressures, including gasoline, diesel, chips, and even health insurance, with many businesses reporting that their profit margins are being squeezed and they are evaluating whether they can pass these costs on to consumers. "This is a very real conversation at present," he said.

If cost pass-through continues to proceed, it will further complicate the downward trajectory of inflation and pose additional challenges for the Federal Reserve in judging whether its tightening policies are sufficient.

The AI boom has become a new variable in policy uncertainty

Barkin listed the momentum of artificial intelligence development as a core uncertainty factor policymakers need to face, assessing its potential impact from two directions.

He stated that if AI fails to meet expectations, business investment may decline, stock prices may fall, and consumer spending reliant on wealth effects will also come under pressure; conversely, if AI exceeds expectations and massively replaces labor, it will lead to a contraction in consumer spending. "Both scenarios will shift the focus towards our mission's maximum employment goal."

Regarding concerns that the construction of data centers is encountering obstacles and may slow the pace of AI investments, Barkin expressed skepticism. "This is a big country," he said, "If they need to build data centers, I believe they can always find some welcoming area."