AI, Oil, and Tariffs Complicate the Fed's Disinflation Scenario

Artificial Intelligence Introduces New Risk for Components

In an interview published on October 6 by Axios, Mary Daly highlights the potential consequences of the surge in demand related to artificial intelligence. The challenge extends beyond building data centers: the significant industry needs for semiconductors and memory could eventually reduce the availability of these resources for other sectors.

The head of the San Francisco Fed reports that some companies are already securing their supplies or revising their product designs. If these tensions spread to the automotive, appliance, or other component-consuming industries, they could exert additional pressure on prices.

Mary Daly believes that the technological shock could last longer than the supply disruptions to which a central bank typically chooses not to respond immediately.

The monetary context has already tightened. On September 16, the Fed raised its target range for the Fed funds rate by a quarter point, now set between 3.75% and 4%. The effective Fed funds rate subsequently stood at 3.88%. Meanwhile, the U.S. Consumer Price Index still showed a 3.4% year-over-year increase in August, according to the Bureau of Labor Statistics.

Oil Adds Additional Pressure on Prices

Energy is identified as the second risk by Mary Daly. Crude oil prices remain high in an environment marked by conflicts in the Middle East and Ukraine. On Tuesday, October 6, Brent crude closed at $100.58 per barrel while American WTI closed at $89.44.

Prices have shown little change during the session, with the market balancing between the recovery of exports from the Middle East and the risk of new supply disruptions.

Persistently high energy prices can fuel inflation directly through fuels, but also indirectly by increasing transportation and production costs. The Energy Information Administration's projections also illustrate ongoing market tensions. For 2026, the U.S. agency anticipates global consumption of oil and other liquid fuels to exceed production, before a clearer increase in supply in 2027. These estimates remain dependent on geopolitical conditions, OPEC+ production policy, and the global economic situation.

Tariffs Could Prolong the Inflation Shock

The third point of concern is the U.S. trade policy. Mary Daly fears that a new round of negotiations could lead to additional tariffs, while businesses have already had to absorb an initial series of tariff changes.

The issue for the Fed primarily lies in the potential accumulation of these factors. More expensive electronic components, sustained high energy costs, and new trade barriers could simultaneously increase business expenses and slow down the disinflation process.

Mary Daly thus supported the 25 basis point rate hike decided by the Fed in September, a decision she deemed necessary in the current context. However, she does not make any assumptions about future meetings: the outcome will depend on the persistence of these shocks, their impact on prices, as well as developments in economic activity and the labor market.

Markets Uncertain About Fed’s Next Move

The rise in inflation risks does not mean that investors expect an interest rate hike at every meeting. Markets continue to adjust their scenarios based on economic statistics, energy prices, and statements from central bank officials.
However, the scenario of persistently high U.S. rates remains. This tends to increase the financing costs for households and businesses and may weigh more heavily on assets whose valuation relies on long-term profits. High U.S. yields can also support the dollar when the interest rate gap with other major economies widens.

France Faces Simultaneous Strain on Its Debt

In Europe, investors are also monitoring the deterioration of the French bond market. Concerns over the trajectory of public finances and political uncertainty have led to a significant increase in the risk premium required to hold French debt.
The yield on the French 10-year OAT was around 4.74% on October 6, compared to about 3.45% for the German Bund of the same maturity. The spread between the two rates was approximately 129 basis points after surpassing 150 basis points in previous sessions. These are levels not seen since the European sovereign debt crisis of the early 2010s.

Debt Costs Are Increasingly Weighing on the Budget

This rise in rates occurs while the state accounts remain heavily in deficit. At the end of August, the state's budget deficit stood at 159.6 billion euros, compared to 157.5 billion a year earlier.
Bercy attributes this development mainly to the increase in debt expenses, military spending, and measures related to the public energy service. However, these figures represent an interim situation during the fiscal year and do not alone determine the deficit level at the year's end.

The 2027 Budget Plan Anticipates Gradual Improvement

The scenario presented with the draft finance bill for 2027 anticipates a public deficit equivalent to 5.4% of GDP in 2026, then 5% in 2027. The government is simultaneously factoring in a growth of 0.5% this year and 1% next year.
These figures are forecasts and not guaranteed outcomes. Their achievement will depend notably on growth, inflation, interest rates, the evolution of the international situation, as well as any changes that might occur during the parliamentary review of the budget.

A More Complex Environment for Central Banks and Investors

The current situation presents central banks with a challenging equation. Inflation driven by supply constraints, geopolitical tensions, or trade measures may persist even as high rates begin to slow the economy.
For the markets, the focus is no longer just on predicting the dates of the Fed's next decisions. It also involves assessing the duration of these various shocks, their ability to impact prices, and the leeway central banks will have if growth slows without inflation quickly returning to their targets.