Former New York Fed Chair: AI Investment Boom May Lead the Fed on an Interest Rate Path of Initial Hikes Followed by Significant Cuts

On October 21 that, according to Jin10 data, former New York Fed President Bill Dudley warned that the AI investment boom may cause the U.S. interest rate path to be more volatile than the market currently expects. In the short term, massive capital expenditures on data centers, semiconductors, and computing infrastructure are driving up economic growth, asset prices, and funding demand, which may compel the Federal Reserve to implement further rate hikes; however, once AI-related capital expenditures peak or financing conditions worsen, that same dynamic could quickly weigh on the economy and drive the Federal Reserve toward a more pronounced rate-cutting cycle.

Dudley noted that while the direct contribution of AI investment to GDP growth could start fading by 2027, its upward pressure on funding costs may persist. Currently, SOFR futures price in an additional roughly 75 basis points of hikes in the Federal Reserve's policy rate by June 2027, after which the trajectory would flatten. He argued, however, that this "smooth path" may understate the volatility inherent in the AI investment cycle.

He also noted that it is highly unlikely the Federal Reserve will hike rates again at next week's meeting. Over a longer horizon, if AI-driven investment continues to fuel demand and inflationary pressures, the Fed could initially move rates to a level exceeding current market expectations; conversely, once AI capital spending and asset prices reverse course, the central bank may be forced to cut rates more rapidly and aggressively.