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AI mania could make it hard for the Fed to cut interest rates, top economist says

Mar 25, 2024, 21:51 IST
Business Insider
Fed Chair Jerome Powell is likely to oversee numerous rate hikes this year.Eric Baradat/Getty Images
  • The stock market's hype for AI will make it hard for the Fed to cut rates this year, Torsten Slok warned.
  • That's because the rally in stocks is easing financial conditions, countering the Fed's tightening efforts.
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The frenzy for artificial intelligence overtaking stocks could make it hard for the Fed to cut interest rates this year.

That's according to Torsten Slok, the chief economist of Apollo Global Management. According to Slok, the Fed may not end up cutting interest rates this year at all, despite the 75 basis points of cuts officials have pointed to in 2024. His outlook is partly due to with the bubble that's stirring up a feed frenzy in the stock market, with investors still gripped by the hype for AI names like Nvidia.

"We are absolutely in an AI bubble, and the side effect of that is that when tech stocks go up, it eases financial conditions. That's making the job a lot harder for the Fed," Slok told the Financial Times on Friday.

Looser financial conditions are counter to the Fed's policy-tightening goals, with central bankers still keeping a close eye on inflation and asset prices.

The fed funds rate is at its highest level since 2001, and while inflation has cooled dramatically from its highs in the summer of 2022, prices are still hovering well above the Fed's 2% target, with consumer prices growing 3.2% in February.

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Slok and other economists have warned inflation could stay higher for longer, meaning the Fed could push out its timeline for rate cuts into 2025. Supply-chain pressures are still lingering in the economy, top economist Mohamed El-Erian recently warned, which suggests prices are likely stickier than they were in the past.

It's possible the Fed could even resume hiking interest rates later this year, Slok said, assuming economic growth continues to accelerate. GDP is expected to grow 2.1% this quarter, according to the Atlanta Fed's latest GDPNow forecast.

Higher for longer rates also means the Fed risks sparking volatility in the "plumbing of the financial system," Slok added, pointing to high debt loads in sectors like commercial real estate. Higher borrowing costs could cause some debtors to fail, potentially resulting in more regional banking trouble.

"That's not my base case at all, but that would be the mother of all pain trades. No one is preparing for that risk," he said of continued rate hikes.

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