Inflation Pressures Shift Beyond Energy  
with Adam Phillips, Managing Director, Investments 

Lower energy prices have provided welcome relief for consumers and businesses in recent weeks, helping ease one of the biggest contributors to inflation. Encouraging diplomatic progress between the United States and Iran has pushed oil prices lower, with gas prices falling about 20% from their mid-May peak. While prices remain above pre-conflict levels, the recent decline is a positive development for both the economy and financial markets.

Even so, investors should be cautious about assuming inflation concerns have disappeared. The situation in the Middle East remains fragile, and renewed geopolitical tensions could quickly reverse recent gains. More importantly, a different source of inflation is beginning to emerge as companies accelerate investments in artificial intelligence.

Businesses are investing hundreds of billions of dollars to build AI infrastructure, including data centers and the advanced hardware needed to support AI applications. That surge in demand has created supply constraints for key components, particularly memory chips. As manufacturers struggle to expand production fast enough, higher technology costs are beginning to work their way through the economy.

Several large technology companies have already announced price increases tied in part to rising component costs. Apple recently increased prices across much of its product lineup, citing higher memory chip costs, while companies such as Microsoft and Nintendo have made similar announcements. As AI investment continues to grow, businesses may increasingly pass these higher costs on to consumers.

This evolving inflation picture reinforces the expectation that interest rates could remain higher for longer. While lower gasoline prices may help moderate headline inflation, persistent price pressures in technology, services, and other sectors could keep overall inflation above the Federal Reserve's 2% target. At this point, the expectation remains that the Fed is more likely to hold rates steady than begin cutting them in the near future.

Investors will receive additional insight this week with the release of the minutes from the Federal Reserve's June policy meeting, along with the New York Fed's survey of one-year consumer inflation expectations. These reports may provide further clues about how policymakers are evaluating inflation risks and what conditions they would need to see before considering future rate cuts.

While lower energy prices are certainly encouraging, investors should continue watching for inflation pressures developing in other parts of the economy. Maintaining a long-term investment perspective remains essential as markets adjust to an evolving inflation environment.

 Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA^®), a CERTIFIED FINANCIAL PLANNER™ (CFP^®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio. 

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Video Transcript: 

Adam Phillips:

Hi, everyone. Welcome to this week's market update. Let's start with some good news. Energy prices have continued to move lower as negotiations between the US and Iran have shown encouraging signs of progress. Lower oil prices are something we've been hoping to see because they can provide relief for consumers, for businesses, and ultimately, for inflation.

Gas prices are down about twenty percent from their peak in mid-May, although they do remain about thirty percent higher than they were before the conflict began in late February. Still, this is a positive development for the markets and the economy, but I also think it's important not to get too comfortable.

We're probably not out of the woods just yet when it comes to inflation. For one, the situation in the Middle East remains fragile. Diplomatic progress is encouraging. It doesn't necessarily take much for geopolitical tensions to flare up again. So while we're happy to see energy prices moving in the right direction, we're not ready to assume that this trend is permanent.

The second issue is one that's been receiving less attention, but I think it could become increasingly important over the coming quarters, and that's the inflationary impact of the AI build-out. We're in the middle of what's really an unprecedented wave of investment in artificial intelligence infrastructure.

Companies are spending hundreds of billions of dollars building data centers, and they're buying hardware that's needed to power AI applications, and that surge in demand is creating shortages throughout parts of the technology supply chain. One area that's receiving a lot of attention is memory chips.

Companies like Nvidia have signed long-term supply agreements with memory manufacturers as they race to secure the components needed for AI systems. These suppliers are struggling to expand capacity quickly enough to keep up. So those higher input costs are beginning to show up in consumer prices. As an example, Apple recently announced price increases of roughly fifteen to twenty percent across much of its product lineup.

They were citing memory chip costs moving higher as one of the key drivers, and I don't think Apple will be the last company to make that kind of announcement. We've actually seen Microsoft, Nintendo, and others make the announcement as well. But as more companies face higher technology costs, we'll likely continue seeing those increases passed on to consumers.

So while inflation may be easing when it comes to energy, we're seeing new inflationary pressures emerge from a completely different part of the economy. From an investment standpoint, I don't think this really changes our broader outlook, but it is something for us to keep an eye on moving forward. For now, this does reinforce our expectation for interest rates to stay higher for longer.

I'm not expecting the Federal Reserve to raise its interest rates. I also don't think they'll have much room to begin cutting rates anytime soon. Inflation is, I'd say it's evolving rather than disappearing or moving lower. Even if gasoline prices fall, persistent inflation in technology, services, and other sectors could keep overall inflation above the Fed's comfort zone, which is two percent. This week, the economic calendar should give us a little more insight into how policymakers think about that challenge.

On Wednesday, we'll get the minutes from the Federal Reserve's June FOMC meeting. We'll be looking for some clues about how concerned the committee members were about inflation and what they need to see before becoming comfortable with rate cuts. We know that Kevin Warsh is not big on communication, so the minutes may not reveal too much, but we'll see.

We'll also receive the New York Fed's monthly survey of one-year consumer inflation expectations. It's an important report because inflation expectations, they can be self-fulfilling. If consumers expect prices to rise, it can influence wage negotiations, spending decisions, and ultimately move inflation higher.

So while headlines may focus on lower oil prices, we'll be paying close attention to whether inflation pressures are quietly building beneath the surface in other areas. So I'm going to leave it there for this week. Thank you all for joining me. Have a great week ahead. I'll look forward to seeing you next week.