Wall Street Anxiety Rises as AI Rout Meets $110 Oil Shock

What happened

Wall Street, which has spent the year betting on staggering AI growth while worrying about stubborn inflation, got a fresh taste of both risks this week. There was a deepening rout in the AI complex that reached into its debt financing. Simultaneously, oil prices hit $110 a barrel, threatening to make inflation harder to contain.

Why it matters

The combination of a slowdown in the AI sector and rising oil prices creates a challenging scenario for markets. The bet on AI growth has been a pillar for optimism on Wall Street, and a rout in this sector can shake investor confidence and perceived value. In parallel, oil at $110 a barrel represents a supply shock that pressures production and transportation costs, with the potential to reignite inflation. This could lead central banks, such as the Fed, to maintain a more hawkish stance for longer, or even consider further interest rate hikes, impacting the cost of capital and economic growth.

Market impact

• Interest rates and bonds: Increased inflation concerns due to oil tend to push Treasury yields higher, as investors demand greater compensation for inflation risk. The expectation of higher rates for longer can also pressure corporate bond prices, especially those of AI companies already facing difficulties.
• Dollar and FX: In a global risk-off scenario and potential for higher US interest rates, the dollar tends to strengthen against other currencies. This is because the dollar is seen as a safe haven, and more attractive Treasury yields can attract capital.
• Equities: The decline in AI stocks and the inflationary threat tend to generate widespread negative sentiment. Technology sectors, especially those with stretched valuations, may suffer more. Rising energy costs can also negatively impact profit margins for companies across various sectors, leading to a broader correction in equity indices.
• Commodities: Oil, already at $110 a barrel, may see increased volatility. Other commodities, especially industrial ones, may feel the impact of a global economic slowdown, although inflation could provide some support.
• Brazil: The global scenario of risk aversion and a strong dollar tends to pressure the real. Imported inflation via oil could complicate the Copom's monetary policy, which might be forced to keep the Selic at high levels for longer, impacting economic activity and the local stock market (Ibovespa).

What to watch

Upcoming inflation data (CPI and PPI) in the US will be crucial for assessing the persistence of price pressures. Additionally, earnings reports from technology companies, especially those linked to AI, will provide insights into the sector's health. Statements from Fed members regarding monetary policy and the evolution of global oil inventories will also be closely monitored.

Scenarios

Base Case: Inflation remains elevated due to oil, leading the Fed to maintain high interest rates for longer, while the AI sector undergoes a deeper correction but without a full collapse. Markets remain volatile. Risk Scenario: The oil price surge intensifies, generating an inflationary spiral that forces the Fed to be even more aggressive, culminating in a global recession and a widespread rout in equity markets, with the AI sector suffering substantial losses.

Original source: Bloomberg Markets. For information only, not investment advice.