On Tuesday, the S&P 500 hit a new record at 7,818 points. Nvidia came within striking distance of a $6 trillion market cap. And the market was celebrating.
Yesterday, however, the FED minutes were released. And the message was very clear. The FED is not done with rate hikes.
WHAT THE MINUTES SAID
Let’s first remember what happened in September. The FED raised interest rates by 0.25%, to 3.75%-4.00%. It was the first rate hike since 2023. And the decision was made with a 12-0 vote.
“And what did we learn that’s new?” you might be wondering.
We learned that there was no disagreement. All 19 members of the committee supported the hike. Not just the members who vote. Everyone.
And this is where things get even more interesting. According to the minutes, most members believe that another rate hike will probably be appropriate by the end of the year.
Of course, there is a big “but.” They did not say when. They only said that they are going into every meeting with an open mind and will make decisions based on the data. And as if that were not enough, several members believe that current interest rates “are not restrictive or are only mildly restrictive.”
What does that mean? In very simple terms, they believe interest rates are not slowing the economy down enough. Even at 4%.
And what about inflation? Almost everyone sees the risks as being to the upside. I remind you that FED Chairman Kevin Warsh said in September that inflation “is too high and has been for too long.”
THE AI PARADOX
And now we get to the most interesting part of the minutes. Several FED members are worried about... artificial intelligence.
“And what does AI have to do with interest rates?” you might be wondering.
In short, companies are spending enormous amounts of money building AI infrastructure. And according to the FED, this is already pushing up prices for certain products. It is increasing companies’ costs. And it is driving up wages for highly skilled workers.
In fact, some members warned that AI could, over the medium term, cause demand to exceed supply. And that, quite simply, creates inflation.
Now look at the contradiction.
That same week, AMD hit a record high, with Lisa Su saying that “demand for compute continues to exceed supply.” And Constellation Energy closed a $4.3 billion deal with Google for nuclear power.
In other words, AI is one of the reasons markets are going up. But at the same time, it could also be one of the reasons the FED keeps interest rates high.
BONDS ARE NOT JOKING AROUND
And this is where bonds come in.
On Wednesday, the 10-year yield reached 5.36% during the day. The 30-year reached 5.73%. Both were at their highest levels since 2002. Yes. SINCE 2002.
Why are they rising so much?
The FED itself says it is mainly due to higher real interest rates. But also geopolitics. And, once again, the enormous amount of borrowing companies are doing to build AI infrastructure.
Despite this, the FED does not appear particularly concerned. Most members believe that financial conditions are still supporting the economy, despite the high yields. They also noted that stocks have risen significantly during the year.
WHAT COMES NEXT
“So when will the next rate hike happen?” you might be wondering.
Here is where things get interesting.
After the September decision, markets were pricing in roughly a 70% probability of a hike at the October 27-28 meeting. Today, they are pricing in just 17-20%.
But for a hike by December, the probability remains around 80-85%.
So why did the outlook for October change so quickly?
Because softer economic data came out after the meeting. August PCE was 3.4%, while core PCE was 3.0%. And in September, the US economy created just 29,000 jobs.
In other words, the minutes were written before this data was released. So the market is reading them with some caution.
The next major event is the CPI report on October 14. If inflation comes in high, an October rate hike could be back on the table.