Inflation is back and ‘markets are running scared’

Wall Street’s sell-off has rippled across Asian markets and into Europe as hotter-than-expected US inflation rekindles fears that the Federal Reserve will be forced to raise interest rates further, threatening to tighten financial conditions just as concerns over debt and artificial intelligence investment mount.

Investors are reassessing the cost of America’s enormous debt burden as higher borrowing costs threaten to make it increasingly expensive to finance.

Anxiety is also building over banks’ and private credit lenders’ exposure to the multibillion-dollar AI infrastructure boom, raising questions about whether the rush to fund data centres and computing capacity has created vulnerabilities in financial markets.

The turbulence presents a fresh test for investors already navigating elevated valuations, uncertain monetary policy and mounting economic risks.

Britain, meanwhile, has offered a more resilient picture. GDP expanded by 0.1 per cent in August, with stronger industrial production offsetting weakness in consumer-facing activity.

The modest increase suggests the UK economy may outperform the International Monetary Fund’s forecast of 1.3 per cent growth this year, offering a potential boost for Chancellor John Healey ahead of the Budget and for Andy Burnham as Labour confronts the challenge of delivering stronger economic growth.

But the outlook remains vulnerable. Higher energy prices threaten to reignite inflation, squeezing households and businesses while complicating the path for interest rates.

For policymakers, the danger is that global financial turbulence and renewed inflation pressure could undermine confidence just as Britain seeks to turn modest growth into a durable recovery.

Susannah Streeter, Chief Investment Strategist, Wealth Club said:”Markets are feeling the heat of steamy US inflation. A sell-off on Wall Street has sparked deep losses in Asia and is spilling into trade in Europe.

“London’s Footsie initially dipped slightly in early trade but appears more insulated from the fallout, given that so many of its constituents are more defensive plays in a multi-year trade that’s focused so heavily on tech winners. Semiconductor stocks, which have been enjoying waves of AI enthusiasm, are among the deepest fallers. With borrowing costs set to soar, with further hikes from the Federal Reserve being priced in, the cost of capital for heavily leveraged projects is coming under question.

“10-year US Treasury yields hit 5.33% after the data was released as investors eyed up the interest rate horizon. They have retreated a little amid hopes policymakers will stay more cautious but given the intractable nature of current conflicts more volatility is likely. This is also creating wariness about the exposure of banks and private credit institutions to the AI buildout, given vast sums have been funnelled into the building of infrastructure to support future demand.

“This once again puts the focus on the affordability of the US debt mountain, and its high structural deficit. If current AI spending levels retreat and American consumers become more cautious, growth is likely to take a hit, which could see the US becoming mired in a compounding debt trap. For now, with the last quarterly snapshot showing GDP running at 2.2% annually, it appears just about manageable, but a deeper loss of confidence could set more alarm bells ringing.

“The UK economy is showing a bit more resilience in the face of the energy crisis and the tense geopolitical situation. Growth hardly shot the lights out in August, coming in at 0.1%, but a contraction had been expected given the deep uncertainty surrounding the repercussions of the Middle East conflict. The data does show that consumers had held back spending compared with July amid rises in fuel costs, but it could also be partly due to more sensible spending patterns returning after the heatwaves and World Cup celebrations. But production provided an offsetting uplift, growing 0.8%, showing plenty of companies were shrugging off the economic volatility and churning out more goods.”