SF Fed president: AI demand could extend energy shock

Some companies are preparing for an AI-fueled chip squeeze that could push up prices far beyond the data center boom alone, Mary Daly, president of the Federal Reserve Bank of San Francisco, tells Axios. Why it matters: The Fed can usually look through supply shocks that come and go. Daly's concern is that AI, tariffs and higher energy costs could last longer than expected or compound each other — keeping inflation elevated and requiring more tightening. State of play: Daly says AI demand could spread beyond high-end chips before supply catches up, extending the shock beyond the period the Fed would normally expect to look through. "I see it less as a one-off," she says, referring to AI-driven pressure on chip and other technology prices. Daly says the Fed typically thinks in terms of shocks fading within one to three years. "This is probably further out before we get relief." "It doesn't seem like the demand for AI is going down. If anything, it seems like it's going up." Zoom in: Daly's district includes Silicon Valley and many of the companies driving the AI boom. In conversations with business contacts, she says, she's starting to hear signs that companies are bracing for tighter chip supplies — suggesting that the AI boom is beginning to alter purchasing and product-design decisions outside the data center sector. Daly says that some firms are seeking forward contracts for memory chips "so that they know they have a supplier." Those contracts can give companies more certainty about future supply — a notable development in the memory sector, a fast-depreciating market where firms typically have less reason to lock in chips ahead of time. Daly says some companies are also beginning to "reengineer their products" to rely less on chips, giving them more room to maneuver in case supplies tighten. "I see that as a signal that there is a little bit of concern this is going to spread more broadly." What to watch: The fear is that the scramble for AI hardware begins competing with the chips used in cars, appliances and other goods — recreating some of the bottlenecks that drove prices higher after the pandemic, Daly says. She points to autos after the pandemic, when chip shortages left manufacturers unable to finish vehicles and pushed prices higher. The risk now is that demand for AI-specific equipment spills into the broader semiconductor market, raising costs for companies with little connection to data centers. Friction point: The Fed could face an awkward problem as AI-driven price pressures spread. The companies fueling the boom are also among the least sensitive to higher interest rates. "These hyperscalers aren't very interest rate-sensitive," Daly says, though she notes they could become more so as they increasingly rely on borrowing to finance the AI buildout. Daly says the biggest AI spending numbers are concentrated among hyperscalers, but plenty of other companies investing in the technology are more sensitive to borrowing costs. That means higher rates can still restrain the broader economy and inflation outlook, even if they do less to slow the firms at the center of the boom. "I do think tightening policy has an effect on the outlook for inflation," Daly says. The bottom line: The AI boom is emerging as a fresh inflation risk for the Fed — one that could spread through supply chains, linger for years and prove more difficult to cool with higher interest rates. Daly affirmed her support for the Fed's interest rate hike three weeks ago, and, as has become the norm among top officials, declined to say much about whether she advocates further action. But she did give a sense of what will shape her view: whether the energy, trade and other shocks that have pushed up inflation this year show signs of abating. What they're saying: "I was very pleased, very supportive of the rate hike we took in September," Daly says. "It seemed completely necessary at this juncture to respond to the fact that inflation risks have gone up." "Whether more will be needed depends on the same set of conditions ... that I mentioned," she says. "If the shocks that we've experienced — tariffs, oil prices from the Middle East conflict, and then AI — if they prove to be conventional shocks where they come, they go, and they have temporary effects, then we may not need more. And I still have some probability on that." "But if they either compound each other or they just simply last longer than we had forecast that they would ... if we have a second round of tariff negotiations that result in more tariffs, then that would be a second shock on top of a first shock. That would extend the period of time over which those shocks would play out." She later added that the Fed's policy committee, the FOMC, is "not going to lose track of the labor market, and we're going to continue to be careful in our deliberations so that we can really dissect whether those shocks are going to roll off or whether they're going to compound, and whether we think that underlying inflation is gaining momentum or it's not." Of note: This framing differs from a view that monetary policy is out of whack with the broader state of the economy and needs adjustment, as heard from some of the more hawkish voices on the committee. Daly's argument implies openness to being done with rate hikes if geopolitical events cooperate in the coming weeks and months. By contrast, some of her colleagues see an economy with broader inflationary forces at play that compel an adjustment to the monetary dials. "In my view, given changes to the economy, we were out of position, and we made an adjustment in the right direction," Fed governor Michael Barr said last month.

Read it at Axios ↗

← Front page