BofA Hartnett: Key indicators show AI is not yet at risk; beware of the impact of a dollar rebound on popular trades

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Has the AI bubble run its course? Bank of America believes it has not yet reached "dangerous levels," and the real risk in the market right now lies in a rebound of the U.S. dollar.

Although market discussions about a potential bubble are heating up, Bank of America strategist Michael Hartnett pointed out in his latest report that the credit spreads of tech stocks are at their lowest levels in years, which means the AI-driven tech rally has not yet reached dangerous territory.

Hartnett further warned that the immediate risk investors should be wary of is not a bubble burst, but an unexpected strengthening of the dollar. The biggest market vulnerability right now is the consensus trade of "shorting the dollar." If the U.S. dollar index sees a "disorderly" rally and breaks above the key 102 level, it could trigger a wave of "risk-off" collective unwinding.

Nevertheless, Hartnett believes that in the inflationary and high-interest rate 2020s, large-scale government debt and continued currency devaluation remain long-term trends. This means that while there is a short-term rebound risk for the dollar, its long-term depreciation trend remains intact, which is also why assets like gold have structural support.

Credit spreads show AI has not yet formed a credit bubble

Regarding the widely discussed AI bubble, Hartnett believes that a "total collapse is unlikely," because current tech stock credit spreads are at their lowest points in 18 years.

Credit spread is the additional yield on corporate bonds relative to risk-free government bonds; narrowing spreads usually indicate that the market perceives a low default risk for the issuing companies.

The report emphasizes that current tech stock credit spreads are at historic lows, indicating that investors are not pricing in potential risks for tech companies in the credit market, which sharply contrasts with the typical late-stage asset bubble scenario (usually accompanied by a rapid increase in credit risk).

This means that from the credit market's perspective, the AI-driven tech frenzy has not yet evolved into a dangerous credit bubble.

The latest EPFR fund flow data further confirms investor optimism. The data show that last week, global funds continued to flow into various asset classes: $24.7 billion into bond funds, $21.3 billion into cash, $19.6 billion into stocks, $5.6 billion into gold, and $600 million into cryptocurrencies.

This broad inflow of funds indicates that, despite talk of a correction, investors overall have not retreated due to concerns about an imminent market crash, and are still actively allocating to risk assets.

"Shorting the dollar" has become consensus—beware the risk of a dollar rebound

So far this year, gold has been the best-performing asset, with year-to-date gains of 41.3%. In comparison, international stocks are up 24.7%, Bitcoin is up 17.7%, U.S. stocks are up 12.3%, and the U.S. dollar index is down 9.2%.

Hartnett analyzes that the continuous depreciation of the dollar is the core driver of the current round of asset price increases.

He points out that over the past 12 months, global central banks have cut rates a total of 168 times, with a frequency second only to during the global financial crisis and the COVID-19 pandemic, injecting massive liquidity into the market, directly weakening the dollar and pushing up assets like gold, cryptocurrencies, and stocks.

This performance divergence clearly reflects the negative correlation between a weaker dollar and stronger risk assets. Therefore, Hartnett believes that as long as the consensus trade of "shorting the dollar" is not disorderly reversed, the macro environment for asset appreciation will continue.

The report further warns that the biggest market vulnerability right now is the consensus trade of "shorting the dollar." If the U.S. dollar index sees a "disorderly" rally and breaks above the key 102 level, it could trigger a "risk-off" collective unwinding of consensus trades including yield curve steepeners, long global bank stocks, and long Nasdaq index.

Nevertheless, Hartnett believes that although there is a short-term risk of a dollar rebound, its long-term depreciation basis remains unchanged, which is also why assets like gold have structural support.

Hartnett admits that, tactically, gold is currently "overbought." However, structurally, it is still an "underweight" asset. Data show that gold accounts for only 0.4% of private clients' assets under management (AUM), and just 2.4% for institutional clients' AUM.

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