The AI boom is a double-edged sword for the economy. While driving growth through massive investment in data centers, it's also a key source of inflation. Prices for essential computer equipment and software have surged 10% year-over-year, directly feeding into broader price pressures.

Contrary to the long-term belief that AI will be deflationary, the current surge in demand for computer equipment for data centers is stronger than supply, causing prices to spike and contributing significantly to producer price inflation (PPI).

Contrary to the recent narrative of services-driven inflation, data shows core goods prices are firming due to rising technology costs and supply chain stress. Meanwhile, key services components like shelter and medical care have been running milder, signaling a potential shift in underlying inflation drivers.

The massive, concurrent AI build-out by large tech firms creates such inelastic demand for components like copper, gas turbines, and memory that their prices are soaring. This tech-specific investment is fueling broader inflation in industrial and hardware markets, a significant ripple effect of the AI boom.

For decades, supply chains were optimized for cost reduction. Post-crisis, the focus has shifted to security, resilience, and localization. This move away from pure efficiency by adding redundancy and increasing defense spending is inherently inflationary, reversing a long-term deflationary trend.

The inflationary impact from the Middle East war will persist well beyond initial gasoline price hikes. Secondary effects on airline fares, diesel fuel, transportation, and agricultural inputs will continue for months, eventually causing an acceleration in core CPI, not just the headline figure.

Even with a mild Core CPI report, a sharp increase in the Producer Price Index (PPI) for intermediate goods indicates that cost pressures are building in the supply chain. These will likely translate to higher consumer prices in the coming months.

While inflation has peaked, it won't return to the Fed's 2% goal. The massive build-out for AI is creating systemic shortages in everything from power and copper to skilled labor. This sustained demand will create an inflationary floor around 2.5%.

Focusing on falling oil prices as a sign of easing inflation is simplistic. Leading indicators like the sectoral breakdown of payrolls and a core PPI that has jumped from a 3% to a 5% handle in six months suggest a stickier, more concerning inflation outlook for the Federal Reserve.