Citadel Securities: Rising interest rates will suppress risk assets, and the Federal Reserve could raise rates as early as September.

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The easing of tensions between the US and Iran has brought brief respite, but Citadel Securities believes that deeper macro headwinds are building and the real test for risk assets may only just be beginning.

Nohshad Shah, head of EMEA fixed income sales at the firm, pointed out in a recent report that the current market environment closely resembles two historical periods—the internet bubble at the turn of the century and the oil-driven inflation shock of the 1970s.

Stubbornly high inflation, a robust labor market, and elevated oil prices mean the Federal Reserve might begin raising rates as soon as September. Meanwhile, whether artificial intelligence can sustain companies’ current lofty valuation expectations is coming under increasingly stringent market scrutiny.

With the overlay of two pressures, risk asset valuations could face a double whammy: if revenue growth from AI-related firms disappoints, while oil prices and interest rates climb to tighten financial conditions, the current market’s high concentration on a single growth theme will become highly vulnerable.

Lessons from History: How Rate Hikes Burst Bull Markets

Shah cites two historical periods as analytic frameworks. In the early 2000s, the triple blow from Fed tightening, rising oil prices, and slowing growth burst the internet stock bubble; in the 1970s, surging energy prices and accelerating inflation constrained the Fed’s ability to backstop the economy, triggering a prolonged bear market in stocks.

Shah distilled a core lesson from these two periods:

"The market’s most vulnerable moment is often not when a long-term narrative collapses, but when the macro backdrop begins to challenge the stock market narrative."

He further pointed out that tightening cycles have historically marked the end of large stock bull markets, especially after investors have become highly concentrated on a single dominant growth theme.

US-Iran Easing Offers Respite, But a Long Road to Normalizing Oil Prices

This Monday saw a significant improvement in market sentiment. The US and Iran reached an agreement to reopen the Strait of Hormuz, global stocks and bonds rose in response, and the market grew optimistic about an end to months of conflict between the two countries.

However, Shah remains cautious. He warns that oil prices are unlikely to fall back quickly in the short term. During the conflict, inventories and strategic reserves were depleted, and normalization of shipping networks, insurance markets, and supply chains will take time.

This means that even if geopolitical risks substantially ease, energy will continue to put pressure on inflation.

AI Valuations Under Pressure: Profit Expectations Face Cost Concerns

Shah also cites his colleague Frank Flight’s research in issuing a warning about the logic behind AI investments.

According to a previous Wallstreetcn article, OpenAI is considering cutting prices for its AI services, a move indicating customers are increasingly sensitive to costs. This raises questions in the market about whether advanced AI models can maintain their current widespread adoption and profitability.

Shah noted that if revenue growth from AI-related firms disappoints, just as high oil prices and rising interest rates combine to tighten financial conditions, the currently high valuations of these stocks will face significant downward pressure.

In his view, the highly concentrated positioning of investors around the single dominant theme of AI is a typical precondition for deep market stress in each tightening cycle.

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