The minutes of the Federal Reserve’s April meeting released earlier this week showed that some policymakers noted a boost to core inflation from price increases in the software industry. However, they also highlighted that increases in that category "may not be good predictors of future overall inflation."
"Some participants noted that recent price increases in the information technology sector had contributed to higher inflation. A few of these participants remarked that, while price increases in the software category were contributing meaningfully to the increase in core inflation, price increases in that category may not be good predictors of future overall inflation," the minutes said.
Analysts at Citi this week pointed out that there was a big difference between the latest readings on the core consumer price index (CPI) and the Fed’s preferred inflation gauge - the core personal consumption expenditures (PCE) price index. The April CPI ticked up 2.8% Y/Y in April, while the core PCE increased 3.2% Y/Y. The Fed’s inflation target is 2%.
"We have been emphasizing that a large significance of the divergence between (core CPI and PCE) in April comes down to surging prices for memory which happen to show up in an (until recently obscure) sub-index of core CPI called ’Computer Software and Accessories.’ As would be expected this index has mostly declined over the last 25 years but is currently up 13.9%YoY," the analysts said.
The technology sector has been mired in a supply crunch for memory chips as demand has exploded since the rapid adoption of AI technology since late 2022. The supply glut has been a big hurdle for chipmakers and mega tech firms spending heavily on AI, especially for the buildout of massive data centers.
Still, the AI trade has seen a furious rally this year that has played a driving role in helping Wall Street return to record levels this year. Notably, the Philadelphia Semiconductor Index - seen as a barometer for semiconductor stocks - posted an 18-day win streak from the end of March till the end of April, the longest such run in its history.
The AI trade helped U.S. equities scale record levels despite a protracted conflict between Washington and Iran and a global bond sell-off driven by increased expectations for interest rate hikes across the world to combat the inflationary shock emerging from surging oil prices.
"Equity prices also enter relatively directly to core PCE through ’Portfolio Management Fees’ meaning the run-up in equity valuations associated with AI is also contributing to PCE inflation," the analysts at Citi said.
The analysts also said this development provided a "dovish opening for Chair Warsh or other Fed officials." Fed governor Kevin Warsh was sworn in as the new chair of the central bank on Friday, in a ceremony overseen by President Donald Trump who handpicked the former Fed governor for the job. Warsh takes charge at a complicated time when Trump has repeatedly called for interest rate cuts but surging oil prices due to the Middle East conflict has made that all but unlikely.
"Rather than a generalized consumer inflation, the increase in memory prices is an increase in the relative price of a narrowly defined good that is in short-supply due to business demand. That type of thought is likely behind the suggestion in the minutes that inflation metrics distorted higher by AI-related price surges may not be good indicators of future inflation," Citi added.
Here are a few AI-linked exchange-traded funds of interest: Global X Artificial Intelligence & Technology ETF, iShares Future Exponential Technologies ETF, and Global X Robotics & Artificial Intelligence ETF.
source https://www.investing.com/news/economy-news/citi-says-ailinked-boost-to-inflation-presents-fed-a-dovish-opening-4708216
