“Price stability is not an end in itself. But it is a precondition to sustained growth and prosperity.” – Paul Volcker, Federal Reserve Chair, 1979–1987
Nearly forty years after Paul Volcker left the Federal Reserve, his legacy as an inflation fighter endures. Early in his tenure, the Fed raised interest rates to restrain inflation and restore price stability. These actions took political courage and helped establish the foundation for a long period of economic growth and prosperity.
The Federal Reserve’s new Chair, Kevin Warsh, appears to share Volcker’s convictions. A recurring theme in Warsh’s public remarks has been a commitment to restoring and maintaining price stability. Like Volcker, he appears willing to accept tighter monetary policy when necessary to bring inflation back to the Fed’s objective.
In this letter, we examine recent inflation trends and three forces that complicate the Fed’s pursuit of price stability in the near term: energy prices, fiscal policy, and artificial intelligence (AI) infrastructure spending. We then consider what moderating inflation could mean for stocks, bonds, and the broader U.S. economy.
Inflation Trends
The cumulative effect of inflation is easy to underestimate. Based on annual Consumer Price Index (CPI) data, a basket of goods that cost $100 in 2016 would cost more than $136 today. That increase reflects average annual inflation of approximately 3.1% over the period, compared with the Federal Reserve’s objective of 2%. The gap may appear modest in any given year, but over time compounding can meaningfully erode purchasing power.
As the chart on the following page illustrates, annual inflation has fallen considerably from its June 2022 peak of more than 9%. Yet the decline has stalled above the Fed’s objective, and recent readings show renewed upward pressure due in part to the introduction of tariffs in 2025 and now the Iran War with its impact on energy prices.
Source: JPMorgan Guide to the Markets, 09/30/2026
Energy Prices
Since the start of the year, oil prices have increased by over 60% as investors have priced in a reduction in supply globally stemming from the Iran War. This has had a trickle-down effect across the global economy, with prices rising due to higher input costs. While the Iran War was initially believed to be a short conflict, a resolution is proving to be more complicated. Extended hostilities in Iran complicate matters for the Federal Reserve as inflation is likely to stay higher for longer under that scenario. Conversely, a durable peace agreement would provide welcome relief for the Federal Reserve and their goal of price stability.
Fiscal Policy
When looking back at the inflationary surge of 2021 and 2022, massive COVID-19 fiscal stimulus to the tune of $4.6 trillion played a significant role. The cumulative fiscal response was equivalent to a substantial share of 2020 GDP and supported demand at a time when pandemic-related disruptions constrained the economy’s productive capacity. This aggressive fiscal response contributed to the inflationary surge, particularly as consumer demand rebounded faster than supply chains could recover. Today, fiscal policy remains expansionary in the face of full employment and an economy that by most measures is performing admirably.
Looking ahead, government spending restraint would likely be welcomed by the bond market and could aid in lowering inflation expectations.
AI Infrastructure Spending
Spending on AI infrastructure is estimated at roughly $600 billion to $700 billion in the United States alone in 2026. Although AI’s long-term productivity benefits may ultimately be disinflationary, the infrastructure buildout is creating inflationary pressure in the near term. An extraordinary amount of capital is competing for a finite supply of construction labor, engineering services, power equipment, semiconductors, memory chips, and electricity. If AI infrastructure spending is approaching its peak rate of growth, however, these pressures could gradually subside in the years ahead.
Financial Markets and Price Stability
Sustained growth and economic prosperity are the aims of any healthy economy, and Paul Volcker was correct in identifying price stability as an essential foundation for both. Over time, moderate and predictable inflation encourages investment, supports economic planning, and creates a more favorable environment for stocks and bonds.
Bonds have endured a difficult period as interest rates have steadily climbed higher from their historic lows in 2020. This year alone, the 10-year U.S. Treasury yield has increased by over 100 basis points, with yields now hovering in the 5.25% range. A sustained moderation in inflation could create a more favorable environment for bond investors. Furthermore, tighter monetary policy that drives inflation lower could eventually allow interest rates—including mortgage rates—to decline, improving housing affordability and supporting consumers and the broader economy.
Stocks, due in part to rising corporate profits, have performed well despite elevated inflation, but they, too, would benefit from greater price stability. Strong economic growth, moderate inflation, and rising productivity have historically been a constructive combination for equity investors.
The forces currently influencing inflation are not entirely within the Federal Reserve’s control. The Fed cannot end a war, determine fiscal policy, or build the power generation required by the AI economy. That said, Kevin Warsh’s prioritization of price stability is an important component of continued U.S. economic vitality.
The Alley Company Quarterly Letter discusses general developments, financial events in the news and investment principles. It is provided for information purposes only. It does not provide investment advice and is not an offer to sell a security or a solicitation of an offer, or a recommendation, to buy a security. The statements and opinions contained herein are solely those of Alley Company and are based upon sources and data believed to be accurate and reliable. Additional information regarding Alley Company can be found by accessing the SEC’s website at www.adviserinfo.sec.gov.
