The Federal Reserve is losing its grip on the narrative. Yesterday’s Personal Consumption Expenditures (PCE) report, showing a sticky 2.7 percent core inflation rate, has effectively silenced the doves. Markets are no longer pricing in a return to the zero-bound era. Instead, we are witnessing the birth of a higher-for-longer reality that few prepared for in the easing cycles of 2024.
The Gapen Thesis and the Neutral Rate
Michael Gapen, Head of US Economics at Bank of America, has shifted his focus from the timing of cuts to the height of the floor. Gapen argues that the neutral rate, or R-star, has moved north. His specific projection suggests a terminal rate of 3.25 to 3.50 percent, a stark departure from the 2.50 percent long-run expectation held by the FOMC earlier this year. This is not a temporary spike. It is a structural recalibration driven by massive fiscal deficits and the capital-intensive nature of the energy transition.
The yield curve is responding to this shift with a renewed steepening. As of the market close on November 26, the 10-year Treasury yield sat at 4.42 percent, reflecting a term premium that has returned with a vengeance. Investors are demanding more compensation to hold long-term debt as the October PCE data confirms that the last mile of inflation is indeed the hardest to travel. The core price index has remained stagnant for three consecutive months, suggesting that current restrictive levels are merely treading water rather than sinking the inflation ship.
The Artificial Intelligence Capex Trap
Productivity is the only escape hatch. The prevailing market sentiment suggests that Generative AI will catalyze a 1990s-style productivity boom, allowing for high growth without inflationary heat. However, the data suggests a different reality. We are currently in the infrastructure phase, characterized by massive capital expenditures that are inflationary in the short term. The latest quarterly filings from hyperscalers like Microsoft and Alphabet show a combined annual capex run rate exceeding 200 billion dollars. This capital is flowing into copper, transformers, and specialized labor, driving up input costs for the broader economy.
The mechanism is simple. AI is currently a supply-side shock to the energy grid. In Northern Virginia and the Silicon Forest, data center demand is competing directly with residential and industrial power needs. This competition is keeping utility costs high, a primary component of the services inflation that the Fed is struggling to tame. While the efficiency gains from AI software might manifest in late 2026 or 2027, the 2025 reality is one of expensive hardware and soaring electricity bills.
Current Macroeconomic Indicators (Nov 27, 2025)
| Metric | Current Value | Trend vs Q3 |
|---|---|---|
| Core PCE (YoY) | 2.7% | Unchanged |
| S&P 500 Forward P/E | 22.4x | Rising |
| 10-Year Treasury Yield | 4.42% | Expanding |
| Federal Funds Rate | 4.50-4.75% | Paused |
The Labor Scarcity Paradox
The labor market is not breaking. Despite headlines of tech layoffs, the unemployment rate remains pinned at 4.1 percent. The specific mechanism at play is labor hoarding in the skilled trades. As AI infrastructure expands, the demand for electricians and HVAC technicians has decoupled from the broader economic cycle. Per recent labor reports, wage growth in these sectors is running at 5.2 percent, significantly above the 2 percent inflation target. This creates a wage-price floor that prevents the Federal Reserve from achieving its mandate through traditional means.
Traders must look past the aggregate numbers. The divergence between the digital economy and the physical economy is widening. While software companies are seeing margin compression due to high compute costs, the physical builders of the AI era are seeing record pricing power. This is the hallmark of a structural shift in the US economy, not a cyclical fluctuation. The Fed’s tools are designed to dampen demand, but they cannot create more power lines or more specialized labor.
The next major data point arrives on December 5 with the release of the November Non-Farm Payrolls. Watch for the ‘Supercore’ services component within the average hourly earnings. If this figure remains above 0.3 percent month-over-month, the probability of a December rate cut, currently sitting at 58 percent according to CME FedWatch data, will evaporate. The market is pricing in a 2026 return to normalcy, but the data suggests that ‘normal’ has been redefined at a much higher price point.
