Fed's Jefferson warns rate hikes possible as core inflation hits 3.4%

Fed Vice Chair Philip Jefferson said the central bank may need to raise rates if inflation fails to cool, as core PCE accelerated to 3.4% in May from 3% in December.

"In a scenario where actual inflation does not start to cool down soon, I believe that it could be appropriate to reconsider our current policy stance," Jefferson said Thursday at the Stanford Institute for Economic Policy Research.

Core inflation has risen steadily this year, with the 12-month PCE rate reaching 3.4% in May, while headline PCE stood at 4.1%. The labor market has added 111,000 jobs a month over the past three months, and wage growth moderated to about 3.5%, a pace consistent with 2% inflation given trend productivity growth.

The FOMC next meets July 28-29. OIS markets have largely priced out expectations for a rate hike after June CPI data showed cooling, but Jefferson's remarks highlight the risk that persistent inflation could force the Fed to reverse course after holding rates at 5.25-5.50% since July 2023.

Jefferson identified three forces driving price pressures: the lingering effects of import tariffs imposed in 2025, the energy price surge from the Middle East conflict, and demand spillovers from the artificial-intelligence buildout. While Fed research suggests tariff effects on goods prices have largely passed through, he noted uncertainty about whether importers may belatedly recover costs they absorbed last year.

On energy, Jefferson said earlier concerns that higher oil prices would feed through to core inflation have diminished after crude fell from its April highs. But crude prices remain volatile, and futures are still elevated relative to pre-conflict levels. The quick succession of supply shocks, he said, raises the risk that inflation becomes entrenched.

AI-related demand is pushing up prices for semiconductors, computer chips, servers and peripherals, Jefferson said. Shortages of memory and storage chips used in AI buildout are driving up costs for retail goods that also use those components. "Optimism about AI may boost investment and consumption today, even before these productivity gains fully materialize," he said.

Labor Market Stability Offers Cover for Patience

Jefferson said the labor market is stable and balanced, with the ratio of job vacancies to unemployed workers near one-to-one — a sharp contrast from the two-to-one ratio when the Fed began raising rates in 2022. Wage growth has moderated to about 3.5%, down from 5% to 6% in 2022, reducing the risk that tighter policy would drive up unemployment.

"The quick succession of shocks raises the risk that inflation becomes entrenched and inflation expectations become unanchored," Jefferson said. However, market-based measures remain anchored near the Fed's 2% target, with two-year and five-year TIPS breakevens at 2.1% and 2.3%, respectively.

Jefferson drew a contrast with 2022, when unanchored expectations forced the Fed to raise rates aggressively. Anchored expectations today allow the central bank to move more deliberately, he said, but do not justify inaction. "When inflation is well above its target and the labor market is near full employment and stable, any serious policy rule calls for raising the policy rate," Fed Governor Christopher Waller said in a July 13 speech.

The divergence between Jefferson and Waller highlights the debate inside the FOMC. Dallas Fed President Lorie Logan has already called for a rate hike, while Jefferson's "well positioned" language signals he does not see an urgent need to act — unless incoming data forces his hand. The last time the Fed used similarly conditional language was in mid-2023, preceding a 25-basis-point hike at the July 2023 meeting.

This article is for informational purposes only and does not constitute investment advice.