• Stubborn inflation is pushing Fed officials to rethink the policy outlook, with rate hike bets building despite the recent decision to keep rates unchanged.
  • Policymakers are pointing to wider price pressures from tariffs, food supply disruptions, energy volatility, and AI infrastructure spending, making the path back to 2% harder than ever.

Federal Reserve officials are growing increasingly concerned about stubborn inflation. So much so that several policymakers are now openly discussing the possibility of raising interest rates later this year.

Despite holding rates steady at their most recent meeting, cracks are forming in the Fed’s consensus as price pressures are holding far above the central bank’s 2% target.

Inflation Remains Stubbornly High

The latest inflation data is offering little relief, with headline inflation at 4.2% YoY, the Fed’s preferred PCE index rising 4.1% YoY in May to its highest level since April 2023, and core PCE hitting a multi-year high of 3.4%. ⁽¹⁾

Richmond Fed President Tom Barkin cited his own concerns, stating that the numbers are too high. He acknowledged tentative signs that inflation might start to moderate, but stressed that it could be difficult to see inflation back at 2% without more action from the Fed or a soft labor market. ⁽²⁾

Inflation has now been running above the Fed’s target for more than five years, a stretch long enough that officials are worried it may be changing how businesses and consumers think about prices altogether.

Multiple Forces Are Driving Prices Up

While the US-Iran conflict pushed energy prices higher, Fed officials are quick to point out that inflation isn’t being driven by energy.

Minneapolis Fed President Neel Kashkari said many factors are driving inflation higher, including tariffs that are raising the cost of imported goods and fertilizer supply disruptions linked to the Strait of Hormuz closure, which are impacting food prices. ⁽³⁾

He also pointed to the major surge in AI infrastructure spending, particularly on data centers and power grids.

Barkin echoed that same view, noting that the AI build-out is adding an inflationary layer that has nothing to do with oil or trade policy. That makes the Fed’s job significantly harder, since these are not pressures that will simply fade when a ceasefire holds or tariffs get adjusted. ⁽⁴⁾

Businesses Are Stuck, And So Is the Fed

Here is where it gets more complicated. Companies are getting squeezed from both sides. Input costs are up. But consumers are resisting higher prices, which limits how much firms can actually pass on.

The danger, as Barkin sees it, is behavioral. Businesses set tomorrow’s prices based on today’s inflation. If today’s inflation stays high, it impacts future decisions, wages, contracts, and pricing strategies. “I do worry about that,” he said. That persistence is what makes the Fed’s job harder than the headline numbers suggest. ⁽⁵⁾

On a recent trip to western Virginia, Barkin found company executives still unsure how much to raise pay next year. Oil prices have eased to pre-war levels, so the urgency has dropped, but the uncertainty has not left the room. ⁽⁶⁾

Rate Hike Bets Are Building

The clearest signal of a shift in thinking came from Kashkari, who stated that he now expects one rate hike before the end of the year. In March, he voted for a cut.

“In June, I’ve changed that to one rate hike by the end of the year,” he said, though he was careful to add that the decision depends on how data unfolds over the coming months. ⁽⁷⁾

Markets are already pricing in a possible September hike. Chicago Fed President Goolsbee would not commit on direction, but said the Fed’s focus is squarely on inflation, not the labor market, which remains stable for now. ⁽⁸⁾

New York Fed President John Williams offered somewhat of a more measured tone, saying he expects inflation to ease and believes current policy is well-positioned. ⁽⁹⁾

The debate for rate cuts is long gone, and now it’s a question of when to hike. For a growing number of policymakers, it is about whether they need to tighten further, and how long they can afford to wait.

Sources: ⁽¹⁾ ⁽²⁾ ⁽⁴⁾ ⁽⁵⁾ ⁽⁶⁾ Bloomberg, ⁽³⁾ CNBC, ⁽⁷⁾ ⁽⁸⁾ ⁽⁹⁾ Reuters