Minneapolis Fed President Neel Kashkari stated to Bloomberg on Thursday that if rate hikes continue, different sectors of the economy will bear different pressures, with the low-return investment sectors feeling the most impact.

He specifically mentioned that industries adjacent to housing are already under significant pressure. Large-scale investments in data centers require funds to be diverted from elsewhere. If around $1 trillion flows into data centers, the market will reallocate capital from sectors like housing, with higher mortgage rates being part of this reallocation. The two-year yield is around 4.88% to 4.90%, higher than the Fed's implied forecast of about 4%, which he described as a significant gap, and the market is not shy about expressing its views.

The economy's resilience still exceeds his expectations. Consumer spending is strong across various sectors, and the labor market is overall healthy, not just in the AI economy. The unemployment rate is at 4.1%, with layoffs and unemployment claims remaining low. Despite concerns about tariffs, geopolitical conflicts, and elevated yields, the economy remains robust. Businesses in the Minneapolis area are more frequently discussing diesel and truck drivers rather than interest rates. The complaints he hears are more about broad inflation.

In the same interview, he mentioned that more rate hikes will be needed to curb the economy as we approach 2027, but he does not have a strong opinion on whether to act at the October 27-28 meeting, keeping an open attitude. He voted in favor of raising the federal funds rate target range to 3.75%-4% at the September meeting last year, with a forecast of another 25 basis points increase this year and one more in 2027. The last meeting of this year is scheduled for December 8-9.

Data since the September meeting shows the economy is performing better than he expected, and inflation remains too high. If resilience continues to exceed expectations and inflation becomes stickier, the policy rate may need to be higher than he currently envisions. If AI productivity materializes as expected, the investment cycle could last a long time. He added at a Council on Foreign Relations event the previous day that if these investments do not translate into productivity, they will become misallocated investments and impact the overall economy. He has raised his estimate of the neutral rate to 3.25%, believing that AI capital expenditures may temporarily push up the neutral rate.

Buyers are data centers and AI capital expenditures, while sellers are housing and related credit. This is a rate-driven reallocation, not a recessionary sell-off. Funds are flowing from low-return, mortgage-financed sectors to computing projects that can withstand higher capital costs. Beneficiaries include the data center supply chain and consumer companies that still have pricing power. The sectors under pressure include housing construction, real estate-related industries, and borrowers priced based on the two-year yield rather than the policy rate.

The market continues to operate amid volatility. Kashkari has not locked in the October meeting, and the path still depends on whether inflation continues to stick. Housing has already completed part of the tightening with higher mortgage rates, while AI spending is pushing up funding demand.

Source: Public Information