New Federal Reserve Correspondent: Waller Suggests 'High Rates Suppress AI Boom', Rate Hike Path Faces Dual Dilemma

Timiraos believes the Federal Reserve is caught in a deadlock of 'needing two interest rates'.

Written by: Dong Jing, Wall Street Journal

After the Federal Reserve's latest announcement to hold steady, Waller stated in a press conference that he would not predict the December decision. Nick Timiraos, a senior reporter for the Wall Street Journal, known as the 'new Federal Reserve correspondent', recently focused on the key signals released by Waller in the latest press conference, addressing a highly sensitive issue for the market: Can high interest rates really suppress this round of AI investment boom?

In an article on October 29, Timiraos pointed out that for a long time, the market has generally believed that the AI industry is financially robust and immune to interest rate changes. However, Waller explicitly broke this assumption, indicating that rising borrowing costs are indeed affecting the pace of expansion in the tech sector.

The article states that Waller presented two contradictory judgments at the press conference—on one hand, he believes that high interest rates are gradually penetrating the AI investment boom; on the other hand, he emphasized that economic growth is spreading to areas outside of AI. These two judgments seem contradictory but together constitute the most challenging 'dual dilemma' on the current monetary policy path of the Federal Reserve.

Waller Questions 'AI Immunity': Interest Rates Will Penetrate Every Crevice

The article mentions that for a long time, there has been a prevailing narrative in the market: the AI boom is too large and cash is too abundant to care about interest rates. This narrative has almost become a 'consensus' in the past few Federal Reserve press conferences. However, Waller directly pointed out this logic at the current press conference.

Timiraos quoted Waller's original words from the press conference:

"There has been a narrative that has circulated for quite a long time, perhaps in this room, and has been reflected in the past few press conferences—tightening monetary policy 'will not affect AI at all because the expected returns for investors are not on the same scale as interest rates.' I am skeptical of this view. Interest rates will penetrate every crevice, and interest rates directly or indirectly affect almost everything."

Waller further pointed out that since the last rate hike, there is evidence showing that investors have become more selective about their investment targets—some high-risk companies have seen a significant increase in borrowing costs. This indicates that the transmission mechanism of interest rates does exist, but its manifestation in the AI sector is relatively lagging.

The 'Crack Effect' of Interest Rate Transmission: Gradual Impact from the Margins to the Core

So how exactly do high interest rates affect the AI boom? There is a key mechanism worth noting.

Timiraos wrote that Marc Giannoni, Chief U.S. Economist at Barclays, provided a clear explanation in an interview: "The idea that anything related to AI is completely insensitive to interest rates seems very extreme to me." He further pointed out that while tech giants may not need to borrow to support their expenditures, those operators and supporting companies building data centers around them find 'debt rates to be an important factor'.

Timiraos believes this is like a large tree—the trunk (tech giants) may temporarily be unaffected by wind and rain, but the branches and roots (supporting companies, debt financing parties) are already under pressure. Former senior advisor to the Federal Reserve and current Chief Economist at BNY Investments, Vincent Reinhart, has a more alarming judgment on this:

"There is a critical point, once reached, it will break. At that point, the Federal Reserve may find that the contraction in spending exceeds its model predictions."

The article states that this logic of 'gradual impact' is the underlying basis for Waller's questioning of the 'AI immunity theory'.

The Other Side of Growth Diffusion: Is Strong Economic Growth Necessarily Inflationary?

The article states that Waller's second judgment is in the opposite direction. He pointed out that attributing strong economic growth entirely to the AI technology wave is a 'convenient but inaccurate' statement. His original words were: "To say that the strength of the economy comes entirely from this wave of new technology is convenient. But in fact, business investment is not only strong but is also spreading."

However, Waller immediately added that he does not believe strong growth necessarily leads to higher inflation, nor does he think it necessarily means higher interest rates are needed. This statement left the market somewhat puzzled—growth is spreading, but does it not necessarily require a rate hike? Reinhart interpreted this as: "He is basically saying, 'We need to do more, but perhaps not too much.'"

Timiraos believes that this ambiguity is precisely the part that the market finds hardest to digest. When a central bank chairman simultaneously sends signals of 'needing to do more' and 'not needing to do too much', the market's expectation anchors will diverge, and this divergence itself will create volatility.

Wall Street's Confusion: Waller's Statements Are 'Neither Clear Nor Convincing'

Waller's remarks have triggered noticeable unease in the bond market. Timiraos noted in his report that during Waller's speech, investors began to reduce their bets on rate hikes next year, while long-term Treasury yields rose slightly—this is a signal of increasing market concerns about future inflation.

Several Wall Street strategists have given critical evaluations of Waller's statements. TD Securities strategists believe Waller 'did not clearly explain why the committee prefers to wait until December to raise rates'. Mark Cabana, head of U.S. interest rate strategy at Bank of America, was even more direct, stating that Waller's answers are 'neither clear nor convincing'. Cabana believes Waller seems to be using recent volatility in risk assets and the slight decline in market inflation expectations to justify holding steady, but these fluctuations 'are not that significant'.

This skepticism from the market reflects a deeper issue: In the context of two years of no progress on inflation, is the Federal Reserve's policy communication clear enough? Bond investors are looking for clear signals from the Federal Reserve committed to bringing inflation back to the 2% target, and Waller's statements clearly do not fully meet this demand.

'The Federal Reserve Needs Two Interest Rates': The Structural Dilemma of Policy Tools

Timiraos pointed out in the article that behind this debate lies a more fundamental policy dilemma. Jonathan Pingle, Chief U.S. Economist at UBS, succinctly captured the essence of the issue:

"It’s almost as if the Federal Reserve needs two interest rates—one for the AI boom and its associated wealth effects in the stock market, and another for all other areas."

This metaphor is very vivid. If the AI boom is insensitive to interest rates, then the Federal Reserve's continued rate hikes to cool down AI will excessively harm housing, commercial real estate, small businesses, and low- to middle-income consumers—areas that are not the main sources of this round of inflation. It’s like using a sledgehammer to drive a nail; the surrounding wall may collapse first.

William English, a former Federal Reserve economist at Yale School of Management, explained from another angle why AI companies are insensitive to interest rates: "If you want to be one of the winners, it means you have to be the first to arrive." In the winner-takes-all competitive logic, companies' sensitivity to funding costs is suppressed by the fear of 'being left behind'. This psychological mechanism significantly undermines the effectiveness of conventional monetary policy tools.

Future Path: Resilience of Inflation and Uncertainty of Rate Hike Endpoint

Looking ahead, Timiraos gathered predictions from several economists regarding the Federal Reserve's policy path, with an overall cautious tone.

Reinhart believes that the risk balance leans towards the Federal Reserve needing to do more in the short term than expected. His reasoning is that energy and commodity prices seem to be stabilizing at a higher level, which will force other prices to follow suit. "They may find inflation to be more resilient than expected, and at that point, they will lose patience in 2027 and have to tighten policy further." This judgment implies that even if the current pace of rate hikes slows, the story of policy tightening may be far from over.

From the overall logical chain, Waller's dual judgments actually constitute a complete framework of a 'dilemma':

If AI is sensitive to interest rates, then the efficiency of rate hikes is higher and the collateral damage is smaller, but it also means greater risks of economic downturn; if AI is insensitive to interest rates, then the Federal Reserve must achieve cooling targets by harming other more vulnerable economic sectors, making the policy costs higher. Regardless of which scenario comes true, the Federal Reserve's decision-making space is narrower than it appears.

In summary, the most important aspect of Timiraos's article is revealing a long-ignored crack in the current Federal Reserve policy discussion—the market narrative of 'AI immunity theory' is being publicly questioned from within the Federal Reserve.

The two contradictory signals released by Waller at the same press conference reflect the real dilemma currently facing the Federal Reserve—concerned that the AI boom is immune to high interest rates, leading to inflation not being suppressed, while also worried that high interest rates may suddenly 'break' at a certain critical point, causing unexpected economic damage. These two concerns point to entirely opposite policy directions.

As Timiraos presents in the article, this is not an equation with a standard answer. No one can currently provide a definitive answer to how sensitive the AI boom is to interest rates, and this answer will largely determine where the endpoint of the Federal Reserve's rate hike path lies.

For the market, Waller's ambiguous statements may itself be a signal: the Federal Reserve itself has not yet figured it out. In this uncertainty, both the bond market and tech stocks need to prepare for more volatility.