Last year, new Federal Reserve Chairman Kevin Warsh believed that artificial intelligence would pave the way for interest rate cuts. Now it is doing exactly the opposite.
Last year, new Federal Reserve Chairman Kevin Warsh believed that artificial intelligence would pave the way for interest rate cuts. Now it is doing exactly the opposite.
in a Wall Street Journal In an op-ed last November about the Federal Reserve, Kevin Warsh said that artificial intelligence (AI) would be a “significant disinflationary force.” Many experts interpreted this to mean that Warsh was suggesting that the benefits of AI could pave the way for the Federal Reserve to lower interest rates further.
A lot has happened since then, including the installation of Warsh as the new chairman of the Federal Reserve. But right now, AI is having the opposite effect and is likely contributing to high inflation.
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In fact, it could be precisely what forces the Federal Reserve to increase interest rates at the end of this year.
Official White House photo by Daniel Torok.
Major AI capex may be driving returns higher
Many have assumed that the Iran war has caused the recent significant rise in bond yields.
10-year Treasury rate data from YCharts.
There’s no doubt he could be a major contributor. The conflict in the Middle East has driven up oil and gas prices. While energy is excluded from core inflation, it tends to have a trickle-down effect on all aspects of the economy. Although many strategists and investors are confident in a clearer deal between the United States and Iran, it still seems too early to suggest that such a deal, if finalized, will definitely hold. Furthermore, oil and gas prices are unlikely to return to pre-war levels.
But even if the deal holds, some experts still don’t believe the war is having the biggest effect on inflation and bond yields right now.
Brian McCarthy, managing director at macroeconomic strategy firm Macrolens, actually attributes this recent rise in bond yields to AI capital expenditures (capex), which have skyrocketed this year.
In 2025, the “Magnificent Seven” spent approximately $400 billion in capital expenditures, much of it for AI infrastructure such as data centers, chips and servers. Most of this is driven by hyperscalers, huge cloud companies like Amazon and microsoft whose infrastructure needs require more and more investments.
The “Magnificent Seven” began the year targeting a 70% increase in AI capital spending, which would take 2026 levels to $680 billion. But after first-quarter earnings reports, that guidance was apparently too vague. The group greatly increased its guidance and now expects estimated capital spending of $725 billion this year.
It’s a staggering amount, and who knows how many times hyperscalers will increase targeting this year.
It is also the main driver of bond yields right now, according to McCarthy, who said the rise in yields is not due to inflation. Bond yields have risen about 50 basis points (half a percentage point) since the war with Iran began (through May 26), but had risen as much as 60 basis points.
However, McCarthy said the breakeven inflation rate increased only 15 basis points in this period, while the rest is attributable to the actual inflation rate. The breakeven rate is based on market inflation expectations, while the actual rate is more closely linked to market growth expectations. McCarthy said:
It is not exclusively or predominantly the Iran war and rising oil prices that are driving this movement. I think it’s the big upward revisions we’ve had in AI capex. We are now looking at the 2025 to 2026 increase in AI capital spending, going from $380 billion to perhaps $800 billion. Those $400 billion and change represent 1.3% of GDP, and that goes directly to GDP growth. So this is a very strong driver of GDP momentum right now.
Warsh is interested in looking at inflation through a new lens
Interestingly, economic trends that are often seen as positive can be viewed negatively in certain scenarios.
For example, in recent years strong jobs reports and historically low unemployment were often viewed negatively by investors because they fueled inflation, thus preventing the Federal Reserve from cutting rates. That seems to be what is happening here, as economic growth is typically seen as positive.
At the time of this writing, investors betting on changes to the benchmark federal funds rate see the Fed keeping rates steady for the rest of the year and then raising them in January 2027. Keep in mind that economic conditions, or at least the view of them, can change quickly, and these odds change all the time.
Warsh has also talked about looking at inflation through a different lens. He wants to focus not on one-off changes driven by geopolitics, meat prices or other “tail risks”, but on the change once all the “one-offs” are removed and on its effect on the economy.
It’s hard to know exactly what this means for Warsh’s first few months and whether he will use this new lens to suggest that inflation is less of a problem than some believe.
However, the market also appears to be testing Warsh as he begins his tenure. If the 10-year U.S. Treasury yield continues to rise toward 5%, it will be harder for Warsh not to contemplate a rate hike, which could anger President Donald Trump.
Considering what McCarthy said and the difference between equilibrium and real inflation, AI could turn out to be the culprit.
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Last year, new Federal Reserve Chairman Kevin Warsh believed that artificial intelligence would pave the way for interest rate cuts. Now it is doing exactly the opposite. was originally published by The Motley Fool
