Fed Semiannual Report: Middle East Conflict and an AI Boom Push Inflation to 4.1%, Keeping Interest Rates Frozen at 3.5%-3.75%

The U.S. inflation “backfire” alert has officially been sounded! The U.S. Federal Reserve (Fed) today (the 10th) submitted its latest Monetary Policy Report to Congress. The report soberly notes that, amid a triple blow—including an energy surge driven by the conflict in the Middle East, early tariff measures, and a surge in demand for AI equipment—U.S. May PCE inflation has rebounded sharply to 4.1%. To fully combat the price crisis that is far beyond the 2% target, the Fed stated that it will keep the benchmark interest rate frozen at the 3.5%–3.75% range, holding its stance steady and shifting toward neutral and cautious, with full commitment to defending price stability.
(Background: “U.S. rate discussions,” such as “rate cuts—first?” “rate hikes first?”—Barclays expects the Fed to hold rates static until 2027)
(Background addition: U.S. M2 first breaks 23 trillion dollars! The market suspects the Fed will restart money printing, and the “Bitcoin as a hedge against depreciation” narrative gains momentum)

Table of contents

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• Three main culprits behind the inflation rebound: Middle East oil prices, tariffs, and AI demand
• Rates continue to be frozen in the 3.5%–3.75% range, reiterating data dependence
• Minor adjustments to the balance sheet; re-examining the policy framework before year-end

The overall U.S. economy is now facing a new wave of an inflation surge driven by the supply side.

At Taipei time on July 10, 2026, the U.S. Federal Reserve (Fed) officially released and submitted the latest issue of its Monetary Policy Report (Monetary Policy Report) to Congress. This report, prepared to accompany the congressional hearings that the Fed Chair is about to hold, sets an extremely heavy and cautious tone. The report reveals that inflation in the U.S. has shown clear signs of rising this year, far deviating from the 2% long-term target set by the authorities—an outcome that has also forced the Federal Open Market Committee (FOMC) to stand firm on the high-interest-rate front in order to tackle stubborn price problems.

Three main culprits behind the inflation rebound: Middle East oil prices, tariffs, and AI demand

In this official report issued by the Federal Reserve Board, it is made clear from the outset that the notable increase in inflation since the beginning of this year is mainly the result of the malignant interplay of multiple external “supply shocks.” First is the Middle East conflict restricting crude oil supply, causing energy prices to soar sharply; second, early implemented tariff policies have begun to be passed through to the cost side, pushing up prices of imported goods; and finally, a global artificial intelligence (AI) technology product investment frenzy has swept the world, leading to a surge in demand for high-tech hardware equipment and further intensifying price pressure.

Reflecting in the core data, for the past 12 months as of May 2026, the year-over-year growth rate of the U.S. overall PCE (personal consumption expenditures) price index has rebounded to 4.1%. Meanwhile, “core PCE,” which excludes food and energy, has also risen to 3.4%. Both key inflation indicators are significantly higher than in the same period last year.

Rates continue to be frozen at the 3.5%–3.75% range, reiterating data dependence

Facing structural risks of stubbornly high inflation, the Fed has kept the target range for the federal funds rate at 3.50%–3.75% unchanged since the beginning of this year, to prevent easing monetary policy prematurely from triggering even more severe stagflation. The report particularly emphasizes that at the June FOMC meeting, all members reached consensus that the policy at this stage will be “fully committed to achieving price stability,” and the future policy stance will remain highly “data-dependent.”

It is also worth noting that in terms of the labor market and the real economy, the U.S. is still showing solid resilience. The report says that the current change in the national unemployment rate is not large and it remains at historical lows, and that overall labor productivity growth is very strong. Although real GDP in the first quarter showed modest growth and household consumption increased only slightly due to high prices, overall the economy is continuing to expand steadily, benefiting from firms’ large-scale additional capital investment—such as investing in AI technologies.

Minor adjustments to the balance sheet; re-examining the policy framework before year-end

On balance sheet policy, the report discloses that, in order to maintain the banking system’s operation with “ample reserves” during the tightening cycle, the Fed has begun proactively purchasing short-term Treasuries since December 2025. At the June meeting, the authorities also reiterated that they will continue this ample reserves policy to ensure safe liquidity in the money markets and the broader financial system.

Finally, in response to new-era economic shifts (especially the impact of AI technology on labor structures), the report announced that the Fed has officially launched a large-scale policy review program. The authorities are setting up 5 independent working groups (comprising both internal and external experts) to comprehensively re-examine five core areas: policy communication, balance sheet policy, data quality, “productivity and employment” in the era of transition, and analysis of the drivers of inflation. They also expect to formally submit recommendations on framework revisions to the FOMC before the end of this year.