AI profits just became more urgent
When you hear people talk about U.S. inflation, a popular narrative is the Federal Reserve (the Fed) is essentially powerless. The argument goes that today’s sticky price pressures are almost entirely driven by outside supply shocks – things like new tariffs, volatile energy costs, and bottlenecks in tech hardware caused by the massive artificial intelligence (AI) investment boom.
And because higher interest rates can’t magically create more computer chips or drill more oil, many believe additional rate hikes are pointless and that the central bank should just stand down. But the broader economic picture reveals that perspective misses the forest for the trees.
The reality is that inflation in the U.S. is a broader and deeper problem than a few supply disruptions. If you look past the headlines, the recent reacceleration in prices is being driven by genuine economic strength and strong consumer demand.
It isn’t just physical goods getting more expensive. Services – even when volatile categories like energy and housing are excluded – have been accelerating and are running well above their pre-pandemic levels.
Even across the middle of the service sector, baseline inflation has bottomed out at a level significantly higher than the decade before the pandemic. That simple fact indicates price pressures aren’t stuck in a few bottlenecked industries – they’re actively spilling over into the rest of the economy.
A huge driver of this persistent service-sector inflation comes down to wages and the labour market. Historically, service-industry wages are closely linked to the final prices consumers pay.
Outside of healthcare, wage growth has stopped falling and remains elevated. In a tight labour market – further constrained by tighter immigration policies – there is a very real chance that wage growth starts picking up again, directly feeding into higher service costs.
Businesses can only keep passing these rising labour and input costs along to customers because overall demand in the economy remains robust. When underlying demand is this strong, temporary or isolated price shocks easily transform into generalised, broad-based inflation.
It’s true that a significant portion of current demand stems from the massive capital expenditure boom around AI, and those tech investments might not react as quickly to standard interest rate moves as traditional corporate spending does.
But being less sensitive to rate hikes isn’t the same as being immune to them. It simply means that monetary policy is still too loose, and the Fed will have to raise rates higher than investors expect to actually slow things down.
With financial conditions still relatively easy, economic growth running above potential, and no real slack left in the system, removing policy accommodation is the Fed’s only real weapon to bring inflation back to target. The Fed definitely has a crucial role to play here, and to get the job done, interest rates will likely have to head higher for longer than most market observers currently anticipate.
What that means for stocks will depend on how strongly investors believe AI profits will emerge and outrun higher rates. The storm clouds continue to build.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
