AI spending boom may keep US inflation and interest rates elevated: Jefferies

The booming investment in artificial intelligence (AI) may be a key factor in keeping U.S. inflation elevated and interest rates higher for an extended period, a new report from Jefferies suggests. The "Greed & Fear" report indicates that substantial spending by major technology firms on AI infrastructure is not only supporting economic growth but also contributing to inflationary pressures.

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One consequence of the stickiness of inflation in America, with headline CPI inflation running at its highest level in three years, is that nominal growth has been running at 5.9% YoY in 1Q26, driven primarily by the still accelerating AI capex arms race.

This situation complicates the outlook for monetary policy, as headline Consumer Price Index (CPI) inflation in America has reached its highest level in three years. Nominal growth has been robust, driven by an accelerating arms race in AI capital expenditures. Financial markets are increasingly pricing in the possibility of further interest rate hikes due to persistent inflation.

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As a result, money markets are now expecting 36bp of rate hikes by the end of 2026 while importantly, the two-year Treasury yield had its biggest one-day move in 14 months rising by 13bp to 4.18% yesterday.

Jefferies notes that investors are anticipating tighter monetary policy in the coming months. Money markets are now expecting around 36 basis points of rate hikes by the end of 2026. This sentiment is reflected in the bond market, where the two-year Treasury yield saw its largest one-day increase in 14 months, rising by 13 basis points to 4.18%. Surveys of business price expectations also show a rising trend, indicating that price pressures are becoming broad-based across the economy.

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While they remain well anchored in terms of the five-year forward measure by the Fed, it is interesting to note that surveys of business price expectations, be they prices paid or prices received, are rising.

Despite these concerns, equity investors are largely focused on the strong earnings growth anticipated from AI investments. Jefferies points out that earnings expectations for U.S. companies have improved significantly, with S&P 500 second-quarter earnings projected to rise by 22.8% year-over-year, up from previous forecasts. However, the report cautions about the market's increasing dependence on a narrow group of AI-linked technology stocks.

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So long as the AI capex focus is ongoing, and the returns are not questioned, the American stock market will continue to focus on the positive earnings revisions.