From Artificial Intelligence to Inflation: Why Markets Face a More Complex Reality
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What matters to you in 30 seconds:
- Geopolitical tensions remain elevated, although renewed US-Iran negotiations suggest diplomacy remains the preferred path. With the US mid-term elections on the horizon, we believe the Trump administration has every interest in finding an elegant way out of a conflict that remains broadly unpopular domestically.
- Higher energy prices could lead to more persistent inflationary pressures. We therefore expect that the Federal Reserve, Bank of England and Bank of Japan to raise their policy rates before the end of the year.
- The Artificial Intelligence (AI) theme remains intact, but investors are placing greater emphasis on profits and valuations rather than growth alone.
Global Markets
Why has confidence become more fragile?
For much of this year, resilient growth, solid earnings, falling energy prices and continued enthusiasm around AI supported markets. Those drivers have not disappeared. However, investors are now weighing a wider range of risks, which helps explain why markets have become more volatile in recent weeks.
Geopolitics remains a key source of uncertainty. Tensions between the US and Iran and disruption to shipping through the Strait of Hormuz have revived concerns about energy supplies and higher oil prices. Persistently higher oil prices could keep inflation elevated and limit central banks' flexibility to reduce interest rates. However, markets welcomed signs that diplomacy remains the preferred path after President Trump announced that negotiations with Iran had resumed, supporting US equities and easing oil prices.
Investors are also adjusting to a less predictable policy environment. US intervention to support the Japanese yen highlighted how policymakers may increasingly use currency markets as another tool to influence financial conditions, with potential implications for global capital flows.
A further source of uncertainty comes from the AI sector. Demand for chips, data centres and digital infrastructure remains strong, but investors are becoming more selective. The focus is shifting from growth alone towards profitability, valuations and returns on investment.
Taken together, these developments are making markets more challenging than earlier this year. However, the broader picture remains constructive. Economic growth is holding up, corporate earnings continue to expand, and investment linked to AI remains strong.
Central Banks
Why policy uncertainty matters?
Last week's central bank meetings confirmed that monetary policy remains a key market driver. The Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (Boe), and the Bank of Japan (BoJ) all left interest rates unchanged, which markets largely expected. However, the more important factor was how little guidance the central banks have about the future path of policy.
In the US, Fed Chair Kevin Warsh has provided less guidance on the future path of rates than investors had become accustomed to with the previous leadership. For investors, this matters because markets often move on expectations as much as on actual decisions. The less clarity the market has on future policy, the more sensitive it can become to economic data and unexpected developments.
This dynamic was visible in bond markets last week. Markets initially welcomed the absence of an immediate rate hike from the Fed, but sentiment quickly reversed as investors struggled to assess its next move, briefly pushing the 30-year Treasury yield to its highest level in nearly two decades, before easing off a little bit on Friday.
We maintain our view that the Fed will raise interest rates by a quarter of a per cent before the end of the year, bringing them within a range of 3.75% to 4%.
Equity Markets
Is AI becoming a victim of its own success?
AI remains one of the most important drivers of global markets. However, recent developments in Asian semiconductor stocks suggest investors are beginning to question whether expectations have become too ambitious.
Several companies reported exceptionally strong earnings but still saw their share prices fall. The debate is no longer whether growth is strong, but whether it is strong enough to justify the current share prices.
Competition is also increasing. Alongside established US technology firms, Chinese competitors are developing increasingly capable and lower-cost alternatives, putting future margins and pricing power under greater scrutiny.
Importantly, the broader AI investment cycle remains intact. Demand for semiconductors, computing power and digital infrastructure continues to grow, and the benefits of AI are increasingly spreading beyond technology into sectors such as industrials, utilities and energy.
The next stage of the AI story may depend increasingly on which companies can convert investment into sustainable earnings. Against this backdrop, we retain a slight overweight to equities, including emerging markets where valuations remain relatively undemanding. Within developed markets, we continue to favour US equities through an equal-weight approach.
This week
Focus on labour market data and activity indicators
Attention now turns to economic data that could provide further clues about growth, inflation and the outlook for interest rates.
In the United States, Friday's employment report will be the main focus. Markets will closely watch both job creation and the unemployment rate for signs of whether the labour market is cooling or continuing to show resilience. Stronger or weaker figures than expected could influence market expectations for future interest rates.
In Europe, investors will focus on activity in the services sector. Final purchasing managers' index (PMI) data for the euro area will provide an updated view of business activity after a challenging first half of the year.
The key question is whether these risks are large enough to alter the broader outlook for growth, inflation and earnings. For now, markets remain highly sensitive to incoming data.
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Information correct as of 3 August 2026.
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