Fed report under Warsh flags AI investment as inflation driver

The Federal Reserve delivered its first semi-annual monetary policy assessment under Chairman Kevin Warsh, highlighting an economy caught between moderate growth and persistent price pressures. The report reveals that the Personal Consumption Expenditures Price Index, the central bank's preferred gauge, was running at roughly 4% in May. This is double the bank's 2% target, indicating that holding rates steady since December has not yet cooled price increases.

Most striking for investors is the report's treatment of artificial intelligence. While Warsh has previously argued that AI will ultimately boost productivity and lower prices, the Fed acknowledged the immediate reality is inflationary. Surging demand for electricity and advanced semiconductors needed for AI infrastructure is lifting costs before those long-term productivity gains materialise.

Overall economic expansion remains modest. Gross domestic product grew at an annualised rate of 2.1% in the first months of 2026, propped up almost entirely by AI-related capital expenditure. This strength in corporate investment masked underlying weaknesses in household spending and a stagnant housing market.

The labour market presents a mixed picture for policymakers. The unemployment rate stood at 4.2% in June, with job openings flat and layoffs subdued. However, the Fed warned that labour force growth has slowed sharply due to weaker immigration and an ageing population. The central bank noted that healthy gains in labour productivity are currently offsetting this demographic drag on productive capacity.

In a significant analytical shift, the report revived discussions around the money supply, featuring the first detailed reference to the metric since 2016. The Fed noted that M2 growth has returned to levels typical of the 2010s, indicating that the massive cash balances accumulated during the pandemic have largely been reversed. This normalization suggests the excess liquidity that fueled post-pandemic demand has diminished, a dynamic that could eventually help restrain price pressures.

The assessment also reviewed monetary policy rules that currently imply a need for higher interest rates, though the central bank cautioned against interpreting these formulas mechanically. This report sets the stage for Warsh's testimony before congressional committees next week, hearings delayed earlier this year amid tensions between the White House and previous Fed leadership. The proceedings will give markets their first direct insight into how the new chairman intends to manage these persistent inflationary forces.