Federal Reserve officials issued warnings about financial market risks, pointing directly to systemic hazards that the artificial intelligence boom may be sowing, while hinting there is still room for rate hikes this year.
In a speech delivered in Washington on Tuesday, Fed Governor Michelle Bowman warned that if AI investment returns fall short of expectations, stock market valuations could face a substantial correction. She also noted that inflation continues to run above expectations, signaling support for another rate hike at the December meeting.
Bowman's remarks echoed inflation data released the same day — Labor Department figures showed core inflation rose 0.3% month-over-month in October, exceeding expectations.
Earlier, two Fed voters struck hawkish tones on the same day. Fed Governor Christopher Waller called for considering a 50-basis-point rate hike at the December meeting earlier that day, while Dallas Fed President Lorie Logan said at least two more 25-basis-point hikes are needed.
AI Returns in Doubt, Stocks Face Correction Risk
In written remarks to the Council on Foreign Relations, Bowman listed AI investment returns falling short of expectations as one of the potential triggers for a sharp correction in stock market valuations, and warned that private long-term interest rates could rise significantly.
"Falling stock prices could weaken the resilience of consumer spending," she said, "while rising interest rates could further suppress interest-rate-sensitive sectors of the economy, such as housing and small business investment."
Bowman also expressed concern about the rapid expansion of AI-related debt. She noted that AI-related liabilities in corporate bonds, private credit, and project finance are on track to exceed $800 billion this year.
She specifically mentioned that large technology companies and hyperscale cloud computing firms use off-balance-sheet liability arrangements to allow smaller, higher-risk companies to use them as collateral for financing data center construction and computing equipment procurement.
"Hyperscale cloud computing companies and chip designers have also made equity investments in smaller companies that purchase their products, creating the appearance of circular financing," she said. This description reveals the intricate capital linkages within the AI industry chain, which could amplify risk transmission under market stress.
Inflation Exceeds Expectations, Signals Need for Continued Rate Hikes
Bowman said recent inflation data exceeded her expectations, with current inflation proving more persistent than previously judged, providing justification for another rate hike this year.
"I currently observe signs of persistent inflation pressure, while labor market conditions appear to be tightening," she said. "This suggests more work is needed to bring inflation closer to the 2% target."
The Fed held rates steady at its October 27-28 meeting, after raising rates by 25 basis points in September — the first hike since 2023.
Bowman said she supported last month's decision to hold steady in order to give the Fed more time to assess economic trends and the transmission effects of the September rate hike.
She also noted that while she expects several factors currently driving inflation higher to ease next year, "the current persistence of inflation has exceeded my expectations."
Multiple Officials Speak Out, December Path Still Divided
There are clear disagreements among Fed officials regarding the next policy path.
Governor Christopher Waller was the most aggressive that day, calling for considering a 50-basis-point rate hike at the December meeting. Shortly after his remarks, the Labor Department's inflation data was released, with the 0.3% month-over-month core inflation reading exactly hitting the threshold Waller had previously set for a "significant rate hike."
Dallas Fed President Lorie Logan subsequently took a similarly hawkish stance. Speaking at a conference in Houston, she said, "Based on the current outlook, the Federal Open Market Committee will need to implement at least two more 25-basis-point rate hikes," but did not commit to supporting a larger move.
According to the Fed's September interest rate projections, most officials had already signaled at least one more rate hike was needed this year. Several officials' recent public statements have continued this stance, believing rate hikes can proceed gradually. The final decision path for the December meeting will largely depend on additional economic data released by then.
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