Inflationary realities dim hope for interest rate cut | Cash Call | Andrew Wong

Because Kevin Warsh was nominated by United States President Donald Trump, the market has generally perceived him as a relatively dovish figure. However, that perception overlooks his track record. During Ben Bernanke's tenure as Federal Reserve chair, when Warsh served as a Fed Governor, his hawkish stance and tough approach to monetary policy earned him the description of a "hard-money hawk." Against this backdrop, expecting Warsh to cut interest rates while inflationary pressures remain persistent would be overly optimistic. It was therefore hardly surprising that, at the Federal Reserve's annual Jackson Hole symposium, Warsh once again reaffirmed his commitment to the Fed's 2 percent PCE inflation target.

Admittedly, Warsh's repeated calls since the July Federal Open Market Committee meeting for changes to the analytical framework used by the Fed in formulating monetary policy have led some investors to believe that he may be willing to tolerate a higher level of inflation. In reality, however, his comments appear to suggest that he is looking for more evidence to justify keeping monetary policy restrictive, or potentially even tightening it further. At Jackson Hole, Warsh highlighted that 54 percent of the underlying components of personal consumption expenditures inflation had annualized inflation rates above 3 percent over the past 12 months, while 49 percent had annualized inflation rates above 3 percent over the past six months. He also pointed to the latest annual increase in the Consumer Price Index of 3.4 percent, which remains well above the Fed's target. Against this backdrop, the probability of a rate hike next month could arguably exceed 50 percent.

Some investors may still be holding on to the view that advances in artificial intelligence could eventually help bring US inflation down, particularly given Warsh's previous comments suggesting that AI-driven productivity gains could be a factor supporting lower interest rates. The reality, however, is that AI remains very much in the development and investment phase. Rather than easing inflationary pressures, the rapid expansion of AI investment is already contributing to shortages in certain technology-related hardware, including GPUs and memory chips. At the same time, the surge in electricity demand associated with AI infrastructure is putting additional pressure on power prices. If AI investment continues to accelerate, it could therefore prove increasingly difficult for inflation to return to the Fed's 2 percent target.

Warsh appears to be confronting this reality, while the US 10-year Treasury yield is also reflecting some of these underlying inflationary and term-premium pressures.

The concern, however, is that the three major US equity indices have yet to fully price in these risks. More importantly, many companies continue to aggressively invest in AI infrastructure while simultaneously increasing their leverage, with insufficient attention being paid to the potential impact of higher interest rates on their future debt-servicing costs.

As a result, the interest-rate factor could become one of the biggest vulnerabilities for US equities in the months ahead. With equity valuations already elevated and corporate investment increasingly dependent on debt financing, a more persistent inflationary environment could force the market to reassess expectations for monetary easing. If that repricing occurs, the impact on equity valuations could be considerably more significant than investors currently anticipate.

Andrew Wong is a veteran independent commentator

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