Citadel Securities has indicated that investors are underestimating the determination of Federal Reserve Chair Waller to bring inflation back down to the 2% target, and the potential pressure this policy stance could exert on risk assets.
In a recent client note, Nohshad Shah, the firm's Head of Fixed Income Sales for Europe, the Middle East, and Africa, stated that despite the recent pullback in global oil prices, it is insufficient to undermine the case for further interest rate hikes by the Fed, as underlying inflationary pressures in the U.S. remain elevated.
Shah pointed out that concurrently, the U.S. stock market rally driven by artificial intelligence is becoming more fragile. A sustained decline in the price of computing power, a slowdown in corporate spending growth on AI services, and rising market skepticism about the return on investment from AI all signify that this AI-driven market phase faces growing challenges.
He noted that unlike the widespread market belief post-COVID-19 that the Fed would swiftly intervene to support the economy or markets during a slowdown or sharp stock decline, recent policy signals from Waller indicate that high inflation has become a significant constraint on monetary policy.
"The market environment may be shifting," Shah suggested, meaning the likelihood of the Fed implementing accommodative policies to rescue markets in the future is diminishing, and the long-held market expectation of a Fed backstop is changing.
Shah stated that the market's focus in the next phase should not merely be on whether the Fed will raise rates once or twice more, but on whether investors will cease viewing every dip in oil prices or brief pullback in risk assets as an opportunity to re-bet on a Fed rescue.
Beyond macroeconomic factors, Shah also cautioned that AI is increasingly evolving into a political issue. He observed that while investors broadly believe AI can enhance productivity and drive corporate earnings growth, a growing number of workers are concerned about potential job losses, increased workplace surveillance, and companies using AI to capture and commercialize employees' long-accumulated expertise.
Shah believes this could lead to stricter regulatory scrutiny, a slowdown in the adoption of AI applications, and increased corporate compliance costs. Even with continued technological advancement in AI, its valuation could be suppressed as a result.
"If the public begins to perceive AI as a transaction where corporations reap the benefits while employees bear the costs, the political winds could shift very quickly," Shah concluded.
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