Will the Fed's Rate Hike Fail to Control Inflation? The 'Inflation Dilemma' Created by Tariffs, Oil Prices, and AI

[By Myungjeong Sun, Block Media] The possibility of the U.S. Federal Reserve (Fed) raising interest rates again is increasing, but there are analyses suggesting that the rate hikes may have limitations in curbing the recent rise in prices. This is largely because the recent inflation in the U.S. is significantly influenced by supply-side factors such as tariffs and rising energy prices rather than consumer overheating. Investments in artificial intelligence (AI) infrastructure are also showing little signs of slowing down despite high interest rates.

Ultimately, if the Fed raises rates, the burden may concentrate more on interest-sensitive sectors such as housing and consumption rather than directly addressing the causes of price increases.

According to Bloomberg on the 10th (local time), the futures market reflects about a 70% chance that the Fed will raise interest rates at the Federal Open Market Committee (FOMC) meeting scheduled for the 15th and 16th.

The market views the Consumer Price Index (CPI) for August, to be announced on the 11th, as a key indicator that will determine whether rates will be raised. According to expert forecasts compiled by Bloomberg, the CPI for August is expected to rise by 0.4% compared to the previous month, while the core CPI, excluding volatile food and energy prices, is expected to increase by 0.2%.

Tariffs and Oil Prices Driving Up Inflation... Limited Effect of Rate Hikes

The problem is that many of the factors pushing up prices in the U.S. are not sensitive to interest rates.

A prime example is energy. Since the war in Iran began in February, international oil prices have surpassed $100 per barrel. The rise in oil prices has contributed to higher gasoline and transportation costs, acting as a factor driving up overall prices in the U.S.

Former President Trump's tariff policies have also increased supply-side price pressures. After announcing a large-scale tariff policy in April of last year, President Trump expanded trade barriers against major trading partners. The rise in import prices and decrease in supply have impacted domestic prices in the U.S.

Typically, central banks raise rates to increase borrowing costs and suppress consumption and investment to control inflation. However, raising rates does not directly lower international oil prices or reduce the prices of imported goods that have risen due to tariffs.

Stephanie Ross, Chief Economist at Wolf Research, stated, "The key factors driving inflation above trend are the Iran war, tariffs, and semiconductor shortages," adding, "Even if the Fed raises rates once or twice, the likelihood of the overall environment changing is low."

There is also a view within the Fed that the price impact of tariffs has largely been reflected in inflation. Christopher Waller, a Fed governor, recently noted, "The price effects of tariffs appear to have mostly been reflected in inflation," and expressed concerns that high energy prices have not yet translated into widespread increases in the prices of goods and services.

Housing Market Freezing While AI Investment Continues... Weakened Effect of 'Rate Hikes'

The AI investment boom is also complicating the Fed's concerns. While high rates strongly affect the housing market, investments in AI infrastructure, particularly in data centers, are showing little signs of slowing down.

Employment in residential construction in the U.S. is trending downward due to high housing prices and interest burdens, expected to decrease after September 2024. In contrast, overall construction employment reached an all-time high in August. The increase in employment in non-residential specialty construction and engineering sectors has offset the weakness in the housing sector, attributed to the expansion of AI data center construction.

JP Morgan Chase forecasts that the capital invested in data centers could reach up to $5.5 trillion by 2030.

The investment capacity of large tech companies is also weakening the effects of rate hikes. According to Barclays analysis, hyperscalers are investing over 90% of their operating cash flow into AI infrastructure. Since they do not rely heavily on external borrowing, even if the financing rates for data centers rise by 0.5 to 0.75 percentage points, the likelihood of changing investment plans is low.

Ajay Rajadhyaksha, Chairman of Barclays Global Research, stated, "The economy has become much less sensitive to interest rates compared to past rate hike periods."

Ultimately, Consumers May Bear the Burden of Rate Hikes

If the Fed raises rates further, the sectors that are likely to feel the shock first are consumption and housing.

Market interest rates are already moving ahead of the Fed's actual rate hikes. The yield on U.S. 10-year Treasury bonds has recently risen to its highest level since 2023. Mortgage rates also rose to 6.85% last week, marking the highest level in over a year.

In a situation where real income growth is stagnant, further rate hikes could pressure discretionary consumer spending on items such as automobiles and appliances.

Christopher Hodge, Chief Economist for Natixis in the U.S., predicts that rate hikes will "apply downward pressure on discretionary spending while slightly slowing economic growth."

For the Fed, this is a difficult choice. While it is hard to ignore the goal of price stability in a still-strong labor market, it is not easy to directly suppress current inflation factors such as tariffs, oil prices, and AI investments even with rate hikes. Rather, households and the housing market, already exposed to high borrowing costs, may bear additional burdens.

Chief Economist Christopher Hodge stated, "The onus is now on the price indicators. If there are no clear signals that inflation is progressing, the Fed will likely raise rates next week."

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