Former Dallas Fed President Robert Kaplan highlights a bifurcated economy. While interest-sensitive sectors like housing and autos are sluggish and impacted by rate hikes, the booming AI infrastructure and defense sectors are largely immune. This creates a policy dilemma, as the Fed's primary tool has limited effect on the economy's strongest growth drivers.
While rate hikes can't solve supply shocks like high oil prices, the Fed still acts to prevent the initial price increase from 'bleeding' into dozens of other items. This preemptive measure aims to stop a temporary shock from becoming entrenched, broad-based inflation, which would be much harder to control later.
The Fed's actions primarily influence short-term rates. According to Kaplan, higher long-duration bond yields (e.g., 10-year Treasury) are increasingly driven by concerns over the ballooning national deficit and the lack of a clear fiscal plan to address it. This disconnect highlights the limits of monetary policy on the longer end of the yield curve.
A subtle factor influencing Fed thinking is the growing divergence in economic gains. AI is accelerating the share of GDP going to corporate profits, boosting company resilience. Meanwhile, labor's share is more muted, with many workers struggling. This dynamic complicates the traditional view of the labor market's health and its role in policy decisions.