Persistent inflation pressures keep expectations for consecutive Federal Reserve rate hikes rising; AI investment risks heighten concerns over financial stability.

As U.S. inflation accelerates again, Federal Reserve officials this week released hawkish signals, further strengthening market expectations for a December rate hike and opening the door to another increase in January next year. San Francisco Fed President Daly said Friday that the Fed will likely need to raise rates further, especially as services inflation trends are worrisome and firms are increasingly finding it difficult to absorb rising costs by compressing profit margins. Meanwhile, the Fed's latest semiannual Financial Stability Report warned that the artificial intelligence (AI) investment boom has pushed equity valuations to remain elevated, and related investment 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 further broadening in the range of price increases, involving a variety of everyday goods and services. This has significantly raised the urgency for the Fed to further tighten monetary policy. 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 the policy rate further, especially 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 believe is most appropriate based on evolving economic conditions." 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 exactly 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 of inflation tends to be stickier, once the upward price trend persists, it may be more difficult 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 these 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 Williams said the current inflation level is "far too high" and the Fed still has work to do. Chicago Fed President Goolsbee described the latest inflation data as "quite unsettling." Dallas Fed President Logan said the Fed may need to raise rates faster than she had previously expected, while Fed Governor Waller even suggested that a 50-basis-point rate hike in December may be necessary. Olu Sonola, head of U.S. economic research at Fitch Ratings, said: "A 25-basis-point hike in December is clearly largely priced in. The real question is how soon the next hike will come and how many more hikes will ultimately be needed." This week, about half of the 19 Fed officials participating 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 large single increase, Cleveland Fed President Hammack reiterated that she favors smaller but more frequent rate hikes. Philadelphia Fed President Paulson said gradual tightening is currently more appropriate. Richmond Fed President Barkin also said rates need to rise further, but the pace of increases should remain cautious. The latest economic data released Friday further intensified market concerns about inflation. U.S. October producer prices posted the largest year-over-year increase since 2022, with transportation and warehousing costs rising sharply, further indicating that price pressures remain broad across the U.S. economy. Because some producer price data are used to calculate the personal consumption expenditures (PCE) price index favored by the Fed, the latest data also imply that future inflation indicators may continue to face upward pressure. Michael Reid, head of U.S. economic research at Royal Bank of Canada, said the Fed now appears increasingly worried about a reacceleration of inflation and hopes to respond in advance by raising rates more frequently, and may even further raise the rate level officials believe will ultimately be needed in this hiking cycle. Influenced by the latest economic data and hawkish remarks 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 each of its next three monetary policy meetings; Santander U.S. Capital Markets expects the Fed to hike once in December and once in March next year. Expectations in financial markets have also shifted markedly. Investors have now priced in 25-basis-point rate hikes by the Fed in December, January and March, whereas before this week the market had only expected hikes in December and March. If the Fed raises rates at both its December 8-9 and January 26-27 monetary policy meetings, it would be the first time since 2023 that it has raised rates at two consecutive policy meetings. The remarks from Fed officials also triggered sharp swings in the U.S. Treasury market. On Tuesday, after hawkish speeches by Waller and Logan and U.S. inflation data that exceeded expectations, 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 triggered global market turmoil. Kathy Bostjancic, chief economist at Nationwide, said the policy signals from Fed officials have been somewhat confusing and have caused large swings in U.S. Treasury yields. With Fed Chairman Warsh not yet commenting on the near-term monetary policy outlook, remarks from other officials are filling that information gap. However, despite rising inflationary pressures, some Fed officials remain concerned that further increases in borrowing costs could exacerbate difficulties in some sectors of the U.S. economy. The housing market is one of them. Data released this week showed that U.S. October existing home sales fell to the lowest level in 16 years, highlighting continued pressure on the housing market under a high-rate environment. Boston Fed President Collins acknowledged Friday that higher rates could further weaken housing affordability, but she also stressed that, over the long term, price stability is more important for the housing market and the overall economy. She said the direction of further monetary policy tightening is clear, but she is temporarily unwilling to judge how high rates should ultimately rise or how fast hikes should proceed. Beyond the housing market, whether U.S. consumers can sustain spending amid persistently rising prices and borrowing costs has also become 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 significantly. However, as the year-end holiday shopping season approaches, she will closely watch consumer performance over the next one to three months to determine whether consumers will cut spending because of higher prices. Daly noted that feedback about insufficient momentum in consumer spending has begun to emerge in Las Vegas, and similar signs have appeared in other U.S. states, not just Nevada. Given that consumer spending accounts for most U.S. economic activity, if consumers begin to significantly cut spending in the future, it could weigh on economic growth and force the Fed to take more factors into account when setting its rate-hike path. At the same time, the Fed is also monitoring financial market risks that may arise from the AI investment boom and the interaction between those risks and monetary policy tightening. The semiannual Financial Stability Report released Friday noted that U.S. asset valuation pressures remain elevated and equity valuations remain high, partly due to market optimism about the prospects for AI technology development. However, investor concerns about tech companies' massive capital expenditure and debt issuance plans have somewhat restrained that optimism. In recent years, as tech giants and AI startups have invested heavily in data centers, chips and other computing infrastructure, the financing model of the AI industry has attracted increasing attention. In particular, circular transaction arrangements such as mutual investment, equipment purchases and computing-power supply contracts between tech equipment suppliers and AI startups have raised market concerns about related investment returns and financing sustainability. Fed Vice Chair for Supervision 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 stock prices could weaken the resilience of consumer spending, while higher rates could further intensify pressure on 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 potential risk events that could pose major threats to the financial system in the future. Respondents believe that with the development of AI technology, the risk of cyberattacks on financial markets is rising. AI lowers the technical threshold for state and non-state actors to launch sophisticated cyberattacks, and the damage that AI models themselves could cause also deserves 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 this Financial Stability Report is not a forecast of future economic or market conditions, but is intended to identify potential vulnerabilities the financial system may face. At present, the Fed still faces the challenge of balancing inflation control against guarding against economic and financial risks. The central bank raised rates by 25 basis points in September this year, lifting the federal funds rate target range to 3.75%-4%, and then kept rates unchanged at its October meeting. Fed Chairman 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 the market widely expects him to maintain his stance of not providing clear guidance on the near-term monetary policy outlook. It is worth noting that the resilience of U.S. economic growth may give the Fed room to raise rates further. Data released last week showed that 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 data release reflecting October inflation. Robert Sockin, chief U.S. economist at PGIM, 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 central banks fail to take sufficiently forceful measures in time to curb inflation, they may ultimately have to tighten monetary policy faster and by more.