Castle Securities (Citadel Securities) suggests that investors are underestimating Federal Reserve Chair Powell's commitment to suppressing inflation, while the AI-fueled stock market rally faces growing concerns.
The firm cautions that the market broadly underestimates the firm resolve of Fed Chair Powell to bring inflation down to the 2% target, and this miscalculation will materially weigh on risk assets.
In a report to clients, Nohshad Shah, the firm's Head of Fixed Income Sales for Europe, the Middle East and Africa, noted that recent declines in oil prices are insufficient to weaken the case for the Fed to raise interest rates, as underlying inflationary pressures remain elevated.
Shah also highlighted that, unlike in the post-pandemic era, Powell is sending a clear signal—high inflation has become a hard constraint for monetary policy, and the Fed will not step in to support the economy or markets during a slowdown or decline as it has in the past. This indicates the long-relied-upon "Fed put" logic is unraveling.
Regarding the AI sector, Shah warned that the AI-driven stock market advance is becoming more fragile. Concurrently, political risks surrounding AI are rising, with factors like tighter regulation and increased compliance costs potentially suppressing related valuations.
The "Policy Put" Framework Faces Unraveling
Shah pointed out in the report that post-pandemic, investors formed a fixed expectation: the Fed would intervene whenever the economy showed weakness or markets experienced turbulence. However, Powell's stance is breaking this logical framework.
"The current landscape may be shifting," Shah wrote. In his view, high inflation has become a constraint for policymakers, significantly reducing the likelihood of market rescue during economic or market softening. This fundamentally diverges from the long-held market belief in the "Fed put."
Shah further noted that a temporary pullback in oil prices should not be interpreted by the market as a signal of receding inflation pressure. Underlying inflation pressures remain relatively high, leaving the Fed's rationale for raising rates unshaken. He wrote:
"The key for the next phase is not whether the Fed hikes one or two more times, but whether investors stop interpreting every oil price decline or every bout of risk asset weakness as a reason to rebuild the old policy put framework."
AI Valuation Logic Under Pressure, Falling Compute Costs a Warning Sign
Castle Securities also issued a warning regarding the AI-driven stock market rally. Shah indicated that falling computing power prices, declining AI service expenditures, and growing market skepticism about whether AI investments will translate into corresponding returns all point to the increasing fragility of this advance.
In Shah's view, the potential risks of AI extend beyond the economic sphere into the political realm.
He noted that while investors see AI as an engine for boosting productivity and driving profit growth, growing concerns among workers about job displacement, privacy surveillance, and companies profiting from employees' institutional knowledge will lead to stricter regulation, slower technology adoption, and higher compliance costs. Even as AI technology itself continues to advance, these factors could weigh on related valuations.
Shah wrote:
"If the public forms a judgment that the AI trade is essentially firms gaining and workers losing, the political winds will shift rapidly."
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