Fed Warns Inflation Could Trigger Wage-Price Spiral, Potentially Derailing Economy

The Federal Reserve has issued a warning to Wall Street that years of above-target inflation could lead to a wage-price spiral, potentially triggering a painful economic downturn.

According to minutes from its recent meeting, which saw Kevin Warsh take over as head from Jerome Powell, the Fed is concerned that Americans may start to permanently expect higher prices. This, in turn, could cause workers to push for raises and businesses to increase their costs, perpetuating a self-fulfilling cycle of inflation.

The warning echoes historical precedent, with economists pointing to the 1970s as a cautionary tale. During that period, a decade of extremely high inflation led to a wage-price spiral that only subsided when Fed chair Paul Volcker pushed the federal funds rate to 20% in 1981, causing a recession.

Today's economic landscape is different, with cheap debt propping up the AI build-out. However, data centers are being financed under the assumption of refinancing at better rates that may not materialize, and an increase in interest rates could break this math, potentially deflating the historically pricey stock market.

As a result, investors should be prepared for a potential rate hike before the end of the year, especially with the recent escalation of tensions in Iran. The Fed's decision to hold off on raising rates may ultimately prove to have been an exercise in waiting too long.