Despite recent U.S. economic data pointing to moderating inflation, there are mounting downside risks from the Iran war, ongoing chip shortages, and newly imposed tariffs. The latest inflation reading in June showed a broad easing trend with headline CPI down 0.4% on the month. Analysts say the softer print could support a less restrictive Federal Reserve stance. However, remarks from the July 29 Fed meeting suggest pressure is building for the central bank to act on inflation.
Recently appointed Federal Reserve Chairman Kevin Warsh is widely seen by analysts as more hawkish than his predecessor. Since taking over, Warsh has moved the Fed away from “forward guidance,” which is the practice of providing signals to the market about the likely future course of monetary policy. Instead, markets will need to lean more heavily on incoming economic data for direction. Below, discover the market outlook for U.S. inflation this year, based on findings from the AlphaSense platform.
Core Inflation Stickiness
Recent inflation data this summer shows a divergence between rapidly cooling headline metrics and sticky core inflation. Headline CPI decelerated sharply in June to 3.5% on the year (down from 4.2% in May) while core CPI, which excludes volatile food and energy components, eased more modestly to 2.6% on the year versus 2.9% in the prior month.
Broker research attributes the deflationary relief in headline CPI to a 5.7% drop in energy prices, following the signing of the U.S. – Iran MOU and temporary ceasefire. Meanwhile, core inflation has remained stickier due to upward forces from the ongoing AI boom. Chip shortages in particular have caused higher prices across the computer software and accessories sector.
What experts are saying about inflation:
Within the defense industry:
Now we start to see again, a shortage in chips. Same scenario that we saw in 2020, 2021 during the COVID crisis… The AI trend is consuming a lot of chips everywhere, so we're going to see a scenario of high inflation in the defense market because you have a big demand and difficulty to supply.
Within agriculture:
The tariffs and global unrest affect pricing of everything. It seems as though when it comes to things that need to get energy sources that need to get through the Strait and the Black Sea, etc., just seems like all of the worldwide unrest is a very good reason for fertilizer prices to increase, whether or not they're justified.
On insurance costs:
Pricing this past quarter hasn't dramatically shifted off of the last quarter of last year. In fact, in most cases a lot of insurers have actually been able to lower their rates in certain jurisdictions. There's perception and then there's reality. I think right now the perception is baking in a higher likelihood that things aren't going to stay this good. Right now the actual reality on the ground is that there's been no need to actually change.
Supply-Side Disruptions
There’s been a resurgence of supply-side volatility in the past month, driven by military escalation in the Middle East and structural shifts in trade policy. On the geopolitical front, the U.S. – Iran MOU was short-lived with the ceasefire collapsing in early July, triggering a spike in oil prices. On July 23, the price of Brent crude rose to $100 a barrel for the first time since May, as renewed fighting raised fears of further supply disruptions. On the policy front, the Trump Administration announced new tariffs on dozens of countries in late July, which will inject structural stickiness into goods prices.
Beyond these near-term shocks, the massive wave of capex into AI infrastructure will continue to introduce demand driven inflation and supply chain bottlenecks. Capex for the top 5 U.S. hyperscalers (MSFT, AMZN, META, GOOG and ORCL) is estimated to be around $900 billion in 2027, according to broker research.
Disinflationary Pressures
While experts suggest the same AI spending is inflationary in the near-term, they also predict that it will turn disinflationary in the medium-term as companies substitute capital for labor, easing wage pressures. The labor market is already showing signs of cooling through a stable-to-modest wage deceleration and a “slow hire, slow fire” equilibrium.
More broadly, the extreme inflationary pressures in the aftermath of the pandemic have largely normalized, with transportation and logistics costs returning to more stable baselines. Shelter costs have also been steadily cooling due to an influx of new apartment supply and a softening in rental rates.
Fed Regime Overhaul
Shortly after taking over as Fed Chair, Kevin Warsh signaled a strategic overhaul to the Federal Reserve’s operating framework during his congressional testimony. He asserted that “inflation is a choice,” and that it’s one that monetary policymakers must choose to defeat. He also called the Fed’s 2020 inflation framework a “mistake,” allowing the Fed to run inflation above 2% to make up for past undershooting.
Warsh has also pointed out AI as a meaningful disinflationary force over the medium-to-long term by expanding the economy’s supply side and boosting aggregate capacity. In addition to dropping the practice of forward guidance on interest rates, Warsh launched five reform task forces to deliver reports by year’s end: communications, balance sheet policy, economic data usage, productivity and jobs, and inflation framework. The Fed left the federal funds rate unchanged at its latest meeting on July 29, so investors and analysts will be keeping a close eye on the next couple of months of economic data for insight on what the next Fed decision in September will bring.
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