At the height of the summer, the mood was optimistic in the world’s financial capitals. Powered by the AI revolution, the US stock market had rallied to a fresh all-time high, as investors bet the multitrillion-dollar investment spree would overshadow the hit from the Iran war. Now the warning lights are flashing red.
As the fighting in the Middle East intensifies without clear sign of a resolution, financial markets have been thrown into renewed turmoil. A slowdown looms in the AI arms race, and tinderbox conditions in the market for government debt are fuelling alarm. In the past week the US government’s borrowing costs climbed to the highest level since 2007, with knock-on consequences for the finances of households, businesses, and other governments worldwide.
The fear is that Donald Trump’s war is igniting higher levels of inflation. The president’s tax and spending plans – driving Washington’s debt levels above $40tn (£29.9tn) – also has investors worried. But as the soaring global oil price to above $100 a barrel stokes heavy selling pressure in the bond market, could shares be the next in line for a crash?
With the S&P 500 index of leading US companies 3% below an all-time high, and a combined value of more than $20tn for the “magnificent seven” tech stocks – Nvidia, Apple, Google, Microsoft, Meta, Amazon and Tesla – the concern is that markets are overextended just as the storm clouds gather for the world economy. Such is the worry over the Iran war stoking inflation that the US Federal Reserve defied Trump this week with its first interest rate rise since 2023. As households and businesses come under pressure from rising energy bills and surging fuel prices, central banks elsewhere are also taking action.
Financial markets suggest the Bank of England will raise interest rates four times before the end of next year, even after it kept borrowing costs on hold this week. The European Central Bank raised rates last week, highlighting the hit to the eurozone from the escalating conflict, and the Bank of Japan raised its policy rate to a 31-year high on Friday. The rationale is that adding to the cost of borrowing will weigh on the economy – limiting the potential for short-term higher rates of inflation from becoming entrenched.
However, it will hit households and businesses already struggling with a cost of living crisis. Job losses will probably rise, in-turn compounding the challenges facing governments swimming in debt. A US recession has historically followed about three to 3.5 years after the first rate rise, on average, Deutsche Bank’s Jim Reid has calculated.
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