Market Report: AI volatility returns as Middle East tensions fuel inflation concerns
Susannah Streeter, chief investment strategist, Wealth Club: “The AI rollercoaster has set off again, just as a fresh escalation of attacks in the Middle East spread fresh jitters across markets, pushing up energy prices and government borrowing costs. Equity markets are set for a downbeat start to the week, after sharp losses in Asia, with a flat start for London’s Footsie and Wall Street stocks looking likely to fall at the start of trading.
US military forces hit dozens of sites in an attempt to wrest control of the Strait of Hormuz from Iran, and Tehran has retaliated by hitting US bases in the region. The war has underlined the huge importance of the waterway, which is so vital for shipments from the region. The Strait has become the United States’ Achilles’ heel in this conflict and Iran’s strongest bargaining chip. It’s a strategic chokepoint that gives Tehran disproportionate leverage despite America’s overwhelming military superiority. With the chance of negotiations seizing up again, and this fresh flare-up of attacks, it’s sent oil prices racing up 4% above $79 a barrel. European and UK gas prices have also surged, back up to levels last seen a month ago. While prices are still not at crisis levels, the creep upwards will ignite fresh inflationary worries and concerns about how far higher interest rates could move. That’s being reflected in the bond markets, with yields on gilts and US Treasuries rising, demonstrating how investors are becoming increasingly skittish about how far central bank policy will have to move to keep a lid on inflation.
The resumption of attacks is hitting airline stocks, with IAG, the owner of British Airways, falling by more than 2% and Wizz Air also lower. Airlines have come under pressure as investors assess the prospect of higher fuel costs and the potential for further disruption to flight schedules in the region. Heathrow has already provided a reminder of how the conflict is affecting passenger demand. The airport reported a 1.8% fall in passenger numbers in June, with 7.2 million travellers passing through its four terminals, down from 7.4 million a year earlier. Heathrow said the decline reflected the “continued suppression of Middle East traffic” because of the conflict, although demand on transatlantic routes remained robust, with around two million passengers travelling between Heathrow and North America during the month. But with missiles landing once again across the Middle East there will be worries that the confidence of the travelling public will be dented yet again, just as there were hopes that flight patterns would start to get back to normal.
There’s been another sharp sell-off of semiconductor stocks after the roaring debut of South Korea’s SK Hynix on the Nasdaq on Friday sparked a wave of profit-taking. The main shares are listed on South Korea’s KOSPI and plunged 15% as investors exited their positions. Given the huge weight of the stock on the index, it triggered circuit breakers as falls of 8% were registered, to stop a broader slide in the index.
It was always going to be a volatile ride after the company’s American depositary receipts began trading at such a heady valuation. The offer was seven times oversubscribed and SK Hynix ADRs initially shot up 14%. The FOMO effect was super strong, with US retail investors fearful of missing out on buying into the stars of the AI show. While companies right now can’t get enough of SK Hynix’s products, there are concerns that a lot of this demand has been front-loaded and will ultimately prove cyclical, as investor attention gradually shifts from the companies building the AI revolution to those finding the most profitable ways to use it. These niggles of worry, combined with inflationary concerns and the drop in sentiment as the war in the Middle East kicked off again, have triggered the sell-off and volatility is set to reign over the sector in the coming days and weeks.
Investors are also bracing for a barrage of corporate earnings, inflation data and fresh scrutiny of central bank policy, which could set the tone for markets over the days ahead. As geopolitical risk swirls, all eyes will be on the new Fed chair, Kevin Warsh, as he appears before the House Financial Services Committee on Tuesday and the Senate Banking Committee on Wednesday. It’ll be the first real opportunity to assess how he intends to lead the world’s most influential central bank, and to what extent he’ll deflect any attempts by the White House to influence policy from the sidelines.
Investors will be hanging on every word for clues about the path for interest rates, especially given that the last Fed minutes showed several policymakers remain concerned that inflation risks haven’t fully receded, keeping expectations for interest rate hikes alive. Tuesday’s inflation report will add fuel to the fire of speculation. Headline CPI is expected to ease to around 3.8%, down from May’s 4.2%, largely because the sharp energy price spike seen earlier this year is expected to have less influence on the annual comparison. However, the key metric will be core inflation, which is forecast to remain stubbornly close to 2.9%, underlining that underlying price pressures have proved much harder to shift. With energy prices moving upwards again and the massive investment pouring into AI infrastructure driving demand for everything from semiconductors and electricity to construction and skilled labour, investors will also be watching for signs that inflationary pressures remain more persistent than hoped.
While concerns about inflation could provide some downside, another burst of strong corporate results could keep the bulls charging. Wall Street’s banking heavyweights are first out of the blocks as second-quarter earnings season gets underway, with JPMorgan, Bank of America, Citigroup, Goldman Sachs and Wells Fargo all reporting this week.
Investors will be looking for reassurance that trading activity has remained buoyant during another volatile quarter, while keeping a close eye on loan quality, net interest income and the outlook for consumer and business borrowing. There is also likely to be plenty of focus on investment banking divisions. After a lull, activity appears to have revved up, with IPOs, secondary share sales and mergers and acquisitions gathering momentum. The huge wave of investment pouring into artificial intelligence is likely to have created fresh financing opportunities. Banks are increasingly well placed to benefit from the next phase of the AI boom – not simply by financing technology companies, but by funding the vast data centres, power infrastructure and corporate acquisitions needed to support the AI revolution.
Closer to home, attention will turn to Thursday’s GDP figures, which are expected to show the UK economy remained highly sluggish in May. Higher energy prices, weak business confidence and cautious consumers are all likely to have weighed on activity. Manufacturing is also expected to have remained under pressure, underlining how fragile the recovery remains. There may also be a chance to gauge the strength of feeling around the Bank of England’s Monetary Policy Committee at Wednesday’s Mansion House dinner. Bank of England governor Andrew Bailey and chancellor Rachel Reeves will set out their latest thinking on the economy, financial regulation and the government’s ambitions for growth. Investors will be listening closely for any hints about the outlook for UK interest rates and whether policymakers believe the economy is finally beginning to turn a corner.
Political developments will also remain on investors’ radar, with Andy Burnham expected to be confirmed as party leader on Friday, putting him on course to become prime minister the following week. His expected arrival in Downing Street has largely been priced in and, for now, investors appear relatively sanguine. Gilt yields had edged back slightly, before the latest ramp higher induced by the fresh attacks in the Middle East. Overall, it suggests bond markets don’t currently see a Burnham premiership as a material threat to fiscal stability; however, some uncertainty will still linger. But with much of the political transition already priced in, and no expectation of an immediate clash with financial markets over fiscal policy, attention has shifted back to the bigger drivers of borrowing costs—inflation, interest rates and the health of the global economy.
While London’s FTSE 100 is largely driven by the global outlook and corporate earnings, due to the international flavour of the companies listed, there could still be a mini-footy bounce incoming for domestically leaning consumer-focused stocks. A little extra cheer may filter through after England’s convincing victory over Norway at the weekend. While the economic impact of a football win is often fleeting, sporting success has been shown to lift consumer confidence, with pubs, restaurants, supermarkets and drinks companies likely to benefit if the feel-good factor encourages celebratory spending.”