Markets price 85% chance of Fed rate hike as AI and tariffs stoke inflation
Persistent inflation driven by AI supply chains, lagging tariff pass-throughs, and geopolitical shocks has markets betting heavily on Federal Reserve rate hikes by year-end.
Investors are now pricing an 85% probability that the Federal Reserve will raise interest rates at least once before year-end, with nearly a 50% chance of two or more hikes. The shift comes as policymakers grow impatient following five consecutive years of inflation exceeding their 2% target. While crude oil prices have retreated as the U.S.-Iran war recedes, underlying price pressures are intensifying across the broader economy.
A massive buildout of artificial intelligence infrastructure is creating significant supply chain imbalances. Hyperscalers are spending hundreds of billions of dollars annually on data centers, draining the supply of memory chips away from consumer electronics and forcing Apple to institute steep device price hikes. New York Fed President John Williams warned that if the boom “creates a sustained impulse to demand relative to supply in inflation, I do think that’s the kind of situation where you don’t look through this,” signaling the central bank cannot ignore tech-driven price spikes.
Trade policy is acting as a delayed inflationary trigger, with 47% of service firms and 44% of manufacturers telling the New York Fed they still have pending tariff-induced price increases to pass on to consumers. Although the Supreme Court struck down President Donald Trump’s global levies, steel tariffs remain intact and the administration is preparing new duties under Section 301 of the 1974 Trade Act. “These results suggest that many businesses are still adjusting their prices, more than a year after tariffs were first introduced,” New York Fed researchers noted, pointing to evidence that tariff pass-through builds incrementally.
Energy and agricultural markets face fresh disruptions from the Ukraine conflict. Ukrainian drone strikes on Russian oil infrastructure have forced Moscow to ban fuel exports, driving diesel futures up 11% on Wednesday. Concurrently, attacks on Black Sea shipping have disrupted grain routes, pushing wheat prices up 4.8% on Friday and a European benchmark up 5.7%.
Agricultural markets face additional risks from a "Godzilla" El Niño weather pattern expected this summer. Capital Economics noted that the previous El Niño drove the largest price increases in coffee and cocoa, warning that soft commodities are highly vulnerable to the phenomenon's uneven global effects. Together, these compounding supply constraints indicate that inflation risks remain skewed to the upside, keeping the Fed on a tight monetary path.
