Fed Must Hike Rates Amid Rising Inflation and AI-Fueled Boom

The US economy has been performing remarkably well despite facing several negative supply shocks, including a sharp drop in immigration and a surge in deportations. The current technological spending boom is driving growth, with global spending on data centers expected to reach $7 trillion over the next few years.

The Federal Reserve (Fed) has maintained its policy rate at 3.5% since the end of last year, but it's clear that the current stance of monetary policy is stimulative and needs to be adjusted to combat rising inflation. The Fed's preferred inflation measure, the core PCE index, rose by 3.4% in the second quarter, well above its 2% target.

AI investment has surged, with memory chip prices increasing significantly after years of falling. The building of AI data centers is also putting upward pressure on electricity prices. Despite concerns about inflation, the labor market is improving, with job growth averaging 75,000 per month in the first half of this year.

The implications for Fed policy are clear: it needs to begin raising rates now if it wants to lower inflation back to its 2% target. The AI buildout has swamped previous capital spending surges, and signs of excess in financial markets have emerged, including record-high margin debt and a $3 trillion private credit industry.