Dovish Case – why the Fed may not go much further
None of this means the Fed is embarking on a lengthy hiking campaign, and the outlook looks more like a recalibration – one or two more hikes that would effectively reverse last year’s cuts – than a cycle. AI sits at the heart of that argument, since it is propping up demand through investment and the wealth effect while making the usual policy arithmetic considerably harder to do.
Much of the AI buildout relies on imported chips and computer equipment, which limits its impact on domestic production and so reduces the rate rise needed to cool it, although the rising cost of those imports is now showing up in US inflation. The labour market also looks looser than the unemployment rate suggests, with retirements, falling participation and AI-related cuts to higher-skilled white-collar roles tilting employment towards lower-paid jobs and keeping wage growth at a benign 3%.
The more awkward point is that AI capital, dominated by fast-depreciating computer equipment, is relatively insensitive to interest rates, so the burden of tighter policy falls on the parts of the economy that are not driving inflation. Investment outside AI is already contracting and the housing market is feeling the pain. Should AI returns disappoint – and transformative technologies have a habit of doing so in the short run – the wealth effect could reverse quickly and tighten conditions without any help from the Fed.
The consensus path reflects that caution, with a December hike potentially followed by a prolonged pause and a reversal in December 2027. That view leans heavily on a post-midterm agreement that improves energy flows from the Persian Gulf and, crucially, brings down shipping and insurance costs, which alongside disinflation in housing – 35% of the inflation basket – could bring inflation back to 2% in the second half of 2027. A longer conflict could mean further hikes in the first quarter of 2027, followed by swifter and deeper cuts later in the year as households and borrowers feel the squeeze.