On Wednesday local time, New York Federal Reserve President John Williams stated that, despite upward inflationary pressure from demand driven by artificial intelligence (AI) investments, the current level of interest rates is "appropriately positioned." He also provided several reasons to support his judgment that inflation has peaked and will gradually decline over the coming quarters.
In prepared remarks for an event in New York, Williams pointed out: "I am confident these investments will support strong productivity growth in the years ahead. But for now, we are in a race between available supply and surging demand." However, he also emphasized: "The current stance of monetary policy is well positioned to bring inflation back to the Fed's 2% target."
"Inflation is undoubtedly too high, currently around 4%, well above the FOMC's long-term 2% target," Williams said, while also offering an optimistic signal: "But there are encouraging reasons to expect that inflation has peaked and will gradually decline over the next few quarters."
He forecasts that overall inflation will fall to around 3.25% by the end of this year, then continue to trend towards the 2% target in 2027, and finally reach the target in 2028.
Williams listed multiple factors supporting his view that inflation has peaked. He noted that the additional price pressures from tariffs have largely been absorbed, housing inflation remains on a downward path, energy prices may have already peaked, the labor market is not adding inflationary pressure, and inflation expectations remain well anchored.
Regarding the supply-demand imbalance triggered by the AI investment boom, he expects this pressure to fade over time. Williams stated: "As more supply comes online, the supply-demand imbalances associated with AI-related investment should gradually ease, although the magnitude and duration of these imbalances remain highly uncertain."
On the economy and employment, Williams expects the U.S. economy to grow between 2% and 2.25% this year. The labor market is showing signs of resilience and stability, with the unemployment rate expected to decline "very slowly" from the current 4.2% to 4% by 2028.
Williams's relatively dovish remarks contrast with recent inflation data and internal Fed divisions. The U.S. Consumer Price Index for June, released the previous day, unexpectedly fell 0.4% month-over-month, with the annual increase dropping to 3.5%, primarily driven by falling energy prices. However, Fed Chair Kevin Warsh clearly stated during congressional testimony that this does not mean "mission accomplished."
Warsh revealed that the Committee will engage in "a good internal debate" at its July 28-29 meeting regarding the extent and timing of using its tools. In fact, policymakers' views on the interest rate path are clearly divided. In the dot plot released last month, half of the 18 officials projected at least one 25-basis-point rate hike this year, with a few officials even leaning towards tightening policy at the last meeting.
Earlier this week, Fed Governor Waller also indicated that if price pressures continue to spread, the Committee may need to raise rates further in the near term. Current pricing in interest rate futures markets also suggests the Fed could resume raising rates as early as September. The federal funds target rate range has been maintained at 3.50% to 3.75% since last December.
It is also noteworthy that Williams's assessment that energy prices have peaked is based on the assumption of oil price declines due to easing geopolitical conflicts. However, as he was speaking, tensions in the Middle East have re-escalated, with oil prices and related energy costs rising again, adding new uncertainty to the inflation outlook.
Comments