Fed Rate Hike May Not Tame Inflation Amid Supply Shocks

The Federal Reserve is considering raising interest rates to combat inflation, but experts warn that this may not have a significant impact on the current price pressures. According to Wolfe Research's Stephanie Roth, even one or two rate hikes are unlikely to change the backdrop of above-trend inflation caused by factors such as the Iran war, tariffs, and the chip shortage.

The recent supply shocks have had a lasting effect on prices, with energy prices being a major contributor. The start of the Iran war in February sent global oil prices above $100 a barrel, raising fuel costs and sending headline inflation higher. Trade policy has also created another shock by raising the cost of overseas goods and curtailing their supply.

However, some Fed officials believe that the brunt of the impact from tariffs has already passed, although they are watchful for evidence that price pressures are becoming more broad-based. In fact, artificial intelligence and construction have proven to be resistant to rate hikes, with demand for data centers and key components remaining strong.

The economy is also less sensitive to rates than in past cycles, according to Barclays Plc economists. Hyperscalers are spending over 90% of their cash flow from operations on AI infrastructure, making it unlikely that they will reconsider their spending plans even if the cost of financing a data center has risen by 50-75 basis points.

As a result, Fed officials may have to put more pressure on consumer spending and borrowing, which is already being affected by higher borrowing costs. Yields on 10-year Treasuries climbed to their highest level since 2023, and mortgage rates hit a one-year high last week.