An AI spending blitz is demolishing new Fed chair Kevin Warsh's argument for interest rate cuts with more price increases about to ripple through the economy
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Federal Reserve chair Kevin Warsh stepped into his new job with a case for lower interest rates on the back of an AI-fueled productivity boom. What he got instead was a $700 billion AI spending blitz that's demolishing his argument for rate cuts anytime soon with more price increases about to ripple through the U.S. economy.
With many tech companies like Microsoft $MSFT, Amazon $AMZN, Meta $META and more under the grip of AI-mania, they aren’t flinching at taking on unprecedented spending commitments to expand their fleet of data centers and secure the equipment needed to run them. Now halfway through 2026, momentum at the Fed has shifted toward the possibility of interest rate hikes.
As the argument goes among AI's evangelists, employees adopting AI complete more tasks at a fraction of the time, and companies produce abundantly with the same number of workers. Profits and paychecks would then grow without stoking inflation. Warsh stuck to his bullish views on Wednesday, refusing to be labeled as an “AI doomer,” and said the U.S. is only in “the first or second inning of this revolution.”
Even at this early stage, policymakers believe the AI revolution is all but unstoppable. Generative AI is no longer viewed as a tool that accomplishes only low-stakes tasks. Most recognize it as an instrument capable of decimating millions of white-collar jobs through automation. Most Fed watchers and financial analysts, though, don’t see evidence yet of broad labor productivity gains from AI that could justify a reduction in the Fed’s borrowing rates. Fed policymakers last proceeded with a quarter-point cut at their December meeting and hit pause ever since.
Instead, they’re zeroing in on the rapid data center buildout that’s swallowing up an enormous amount of storage and memory chips — critical components in smartphones, video game consoles, cars, and more — as a culprit for another wave of inflation. The gobbling frenzy weakens the case for lower interest rates further, and policymakers tasked with assessing the fallout of AI are taking notice.
Cleveland Federal Reserve President Beth Hammack said she had not observed enough “restraint” in the US economy, particularly among tech companies gobbling up critical semiconductor equipment at any price.
“What they say is that the demand is insatiable, that these companies — these hyper scalers — will pay almost any price for those inputs, and they need things built yesterday,” Hammack, a voting member of the Federal Open Market Committee, told CNBC on Wednesday. “I’m not hearing from these businesses that interest rates or credit spreads are a reason why they’re holding back from investment and growth.”
A new survey released Monday from the National Association of Business Economics showed that 80% of economic forecasters surveyed expected the AI buildout to be inflationary. The Fed's preferred inflation gauge showed prices rising 4.1% in May, the largest bump in two years. Even as the initial oil price shock from the war with Iran begins to fade, the AI spending craze might replace it as another drag on Americans' personal finances.
Even corporate titans aren’t immune from chip shortages in the AI spending blitz, which will soon trigger fresh sticker-shock among price-sensitive consumers battered by Trump's tariffs and a spike in gas prices. Apple $AAPL raised prices by at least $150 for their latest iPads and MacBook models last week. Speculation is mounting that iPhones will soon follow suit in the fall.
More large companies are doing the same or discontinuing products that are no longer profitable. Nintendo said in May it was hiking the price of its latest handheld video game console. Microsoft did the same for its Xbox consoles and raised prices by at least $100 starting August 1. The company said it expected the cost of memory and storage chips to double by the end of next year.
Warsh, though, maintains that the gusher of AI spending will eventually produce enough productivity gains to relieve demand pressures.
“The AI shock is leading to a boom in capital expenditures. We see that first and foremost in demand, but I’m confident we’re going to see it in supply at some point,” Warsh said at an annual European Central Bank forum in Portugal. “So we’re spending most of our time trying to monitor those developments."
He held off on stating whether he believed a rate hike was necessary at this point. “I’m not going to make a judgment now,” he said. Investors are filling in the blanks on their own and pricing in one rate hike by October.
It's an open question when — or even if — AI will ever deliver the productivity gains that companies and investors are banking on to justify their huge red ink. For now, firms especially in the tech sector are taking for granted that the AI feeding frenzy will continue without turbulence. If policymakers follow the Alan Greenspan Fed playbook and opt for a rate hike to quash speculation, investors may soon get it.
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