Fed Faces Debate Over Rate Hikes Amid Supply-Driven Inflation
New Fed chair Kevin Warsh must decide whether to raise rates as inflation, now around 3.5%, is driven mainly by supply shocks such as the Iran-related energy squeeze and tariffs, rather than strong demand.
New Federal Reserve chair Kevin Warsh has pledged to bring inflation back to the 2% target, prompting speculation that the central bank could raise interest rates as early as Wednesday. However, economists warn that the current inflationary pressure stems largely from supply disruptions, including the war with Iran that has pushed up energy prices and lingering tariffs that raise the cost of some imports.
"Rate hikes won’t keep the bombs from dropping," said former Fed official Benson Durham, founder of DASM LLC. Moody’s chief economist Mark Zandi told CNN that standard monetary policy advises against tightening when inflation is caused by supply shocks, adding that aggressive rate hikes could destabilise the stock market and risk a recession.
Former Fed chair Janet Yellen recently argued the Fed’s default approach should be to look through supply-driven inflation, noting that tightening could trigger unacceptable unemployment unless inflation expectations sharply rise. Market-based measures of expectations remain well below that threshold.
Analysts estimate the Iran conflict contributes about 0.66 percentage points to year-end inflation, tariffs about 0.17 points, and restrictive immigration policy a smaller share. Stephanie Roth of Wolfe Research said none of these factors would be alleviated by higher rates, and Goldman Sachs economists found little reason to expect modest hikes to curb inflation.
A separate source of price pressure is the artificial-intelligence boom, which has driven up demand for memory and storage components. Apple has cited a surge in memory demand linked to AI data-center expansion as the reason for recent price increases on its products.
The market is split on the Fed’s next move, with CME FedWatch showing a 38% probability of a hike and a 62% chance of holding rates steady. Warsh has resisted providing forward guidance, arguing it can constrain policymakers. JPMorgan’s chief global strategist David Kelly described current inflation as “Teflon inflation,” suggesting it will gradually ease without aggressive policy action, though he cautioned that lasting affordability may require higher wages rather than lower prices.