There's a New Source of Inflation, and It's Put Fed Chair Kevin Warsh and the FOMC Between a Rock and a Hard Place

Despite short-lived periods of volatility, it's shaping up as another phenomenal year for Wall Street and investors. With the artificial intelligence (AI) infrastructure build-out as the primary catalyst, the Dow Jones Industrial Average (DJINDICES:^DJI), S&P 500 (SNPINDEX:^GSPC), and Nasdaq Composite (NASDAQINDEX:^IXIC) have catapulted to several record highs this year.

But expecting stocks to continue marching higher in the face of persistently elevated inflation is a tall order.

Kevin Warsh may be staring down a no-win scenario concerning inflation. Image source: Official Federal Reserve Photo.

In September, Fed Chair Kevin Warsh and the Federal Open Market Committee (FOMC) raised interest rates by 25 basis points, kicking off only the fourth rate-hiking cycle of the 21st century. While Trumpflation (Inflation specifically driven by President Donald Trump's policies) has frequently made headlines, a new source of inflation identified by FOMC policymakers has put the central bank between a rock and a hard place.

The Fed has identified a new source of inflation, and it can sink the stock market

The U.S. inflation rate has spent the last 67 months above the FOMC's long-term 2% target, prompting action by Fed Chair Warsh and his colleagues.

Two of President Trump's policies have been regularly singled out as core drivers of inflation: tariffs and the Iran war.

A newly published report ("How Fast Do Tariffs Pass Through into Consumer Prices") by three New York Federal Reserve economists writing for Liberty Street Economics estimates that Trump's tariffs increased goods price inflation by 2.9 percentage points by February 2026.

New from the New York Fed: "By February 2026, tariffs had contributed 2.9 pp to goods price inflation, and without them goods prices would have fallen slightly." About one quarter of every point in higher tariff rates shows up in consumer prices within one year. • A 10% across-the-board tariff yields a 2.6% rise in consumer goods prices after one year. • About two thirds of the increase comes from pricier imports, which get passed through quickly. • Another third comes from U.S. made goods, as producers face higher input costs and less import competition. This takes longer, about 6-12 months, to filter through.

— Nick Timiraos (@NickTimiraos) October 6, 2026

Meanwhile, the ongoing closure of the Strait of Hormuz, caused by the Iran war, represents the largest modern-day energy supply disruption. Gas and diesel prices have skyrocketed in its wake.

But combating Trumpflation is a relatively straightforward venture for the central bank. Attempting to deliver price stability amid a newly identified source of inflation is a different story altogether.

Shortly after Kevin Warsh became Fed chair, the FOMC meeting minutes singled out the AI infrastructure build-out as one of the core sources of elevated consumer prices.

On the one hand, overwhelming enterprise demand for graphics processing units (GPUs), high-bandwidth memory (HBM), rack servers, and storage solutions has been a key growth driver for the U.S. economy and stock market. Ongoing supply shortages for GPUs and HBM, coupled with otherworldly demand, have afforded AI hardware companies exceptional pricing power.

The AI boom is transforming one of the biggest deflationary forces into a key source of US inflation: Import prices for computer and electronic products surged +7.4% in the first 6 months of 2026, to 77.1 points, the highest since January 2016. This also marks a +8.0% YoY jump, the largest annual increase on record. This represents a historic reversal from a downtrend which persisted for over two decades. Between 2006 and 2019, computer and electronic product import prices fell -30%, as improving technology and manufacturing efficiency consistently pushed costs lower. Now, the AI investment boom is straining manufacturing capacity for semiconductors, servers, and electronic components, as companies race to build out AI infrastructure regardless of cost. The AI revolution has flipped technology from a long-term source of deflation into a major driver of inflation.

— The Kobeissi Letter (@KobeissiLetter) July 21, 2026

At the same time, this never-before-seen pricing power is adversely impacting consumers. The variables pushing up chip, memory, and storage prices are increasing the cost of laptops, smartphones, and other tech devices. This dynamic is unlikely to change unless the AI hardware supply shortage wanes and/or an AI bubble forms and subsequently bursts.

Inflation driven by the AI infrastructure build-out puts Fed Chair Warsh and the FOMC in quite the bind. If they leave interest rates unchanged for the foreseeable future, inflation may continue its upward trajectory, eventually harming the economy.

Conversely, if they get aggressive and raise rates multiple times over the next year, higher borrowing costs might halt the AI build-out in its tracks. Derailing a historically pricey stock market's No. 1 catalyst could knock the Dow, S&P 500, and Nasdaq Composite off their respective pedestals.

The unpleasant reality is there may not be a winning scenario for the Fed or Wall Street.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.