Trader angst pivots from inflation to growth as tech rout deepens

The rout in tech stocks further clouds the outlook for a global economy bolstered by the AI boom, leaving traders questioning whether central banks will have scope for further interest rate hikes to contain an Iran war-induced energy price surge.

Market bets on the U.S. Federal Reserve and European Central Bank raising rates in December were less confident on Friday, a day after the tech-led Nasdaq index suffered its deepest one-day drop since the April 2025 “Liberation Day” drubbing.

The selloff, wiping out trillions in market value, came after U.S. Democrats swept midterm elections, adding fears of greater AI scrutiny and curbs on data centre construction to concerns about the huge cost of the AI build out.

As the equity rout broadened, with Taiwan shares posting their worst week since 2001, tighter global financial conditions and the hit to consumers could slow economic growth, limiting the scope for further rate hikes even as energy prices spike.

“The stock market is inextricably linked to the economy, particularly the U.S. economy, and financial conditions are going to be paramount,” said Tim Graf, head of macro strategy for EMEA at State Street.

“When you start to impact equity valuations and asset values… the wealth effects that fuelled growth or contributed to fuelling consumer-led growth go in reverse,” he said.

Rate-sensitive U.S. 2-year bond yields were on track to fall 10 basis points for a second straight week, while French and German 2-year yields were down 19 and 7 bps on the week respectively .

Markets price a roughly 60 per cent chance of a December ECB rate hike, down from 75 per cent last week, while traders see a 58 per cent probability of the Bank of Japan leaving rates unchanged next month, versus 42 per cent odds of a hike.

They price a roughly 70 per cent chance of a December Fed rate hike, down from over 80 per cent last week.

“The tightening of U.S. financial conditions could prove more important in deciding Fed policy action in December than today’s NFP (nonfarm payrolls) report,” said MUFG senior currency analyst Lee Hardman.

U.S. household wealth rose at a record pace in the second quarter on a surge in equity holdings, while the S&P 500 is up almost 60 per cent over a five-year period.

South Korea is particularly exposed to an AI downturn, with the data-centre boom increasingly important to its exports, investment and stock market.

Bank of Korea policy-makers have stressed that actual memory prices, rather than chipmakers’ share prices, are more important in assessing the real economy.

“On the economy, downside risks to private consumption appear quite likely in (the fourth quarter),” said Jin-Wook Kim at Citi, who expects 25-basis-point rate hikes in November and February. But a sharp drop in memory prices and semiconductor exports could prompt the central bank to pause after November, he said.

For other emerging markets, the implications are less clear-cut. A global risk-off move could weaken currencies and add to inflation pressures, limiting central banks’ ability to respond to slowing growth.

“Greater policy dispersion is to be expected rather than a synchronized policy reaction, with central banks needing to balance inflation risks against tighter market-led financial conditions,” said Manulife portfolio manager Elina Theodorakopoulou.

Wait and watch?

Analysts cautioned it was still early to tell whether the tech selloff was a correction from lofty levels or the start of a deeper move that slows growth sharply.

“It does increase the risks of some downside in the short-term,” said Ross Hutchinson, head of euro market strategy and economics at Zurich Insurance. “But the longer-term situation looks to be more sustainable.”

He said the bull case for AI is not about data-centre building but about a boost to productivity driving economic activity and corporate earnings.

The International Monetary Fund, which forecasts global growth at 3.1 per cent this year, says a steep drop in AI investment could slash global GDP by 1.1 per cent by 2028 in one downside scenario.

The prospect of slower growth, which could ease price pressures, helps explain the pullback in rate-hike bets. But central banks are also grappling with higher energy prices.

“For central banks, the impact on inflation dynamics stemming from elevated energy prices arising from the Middle East conflict is still a central focus,” said Phoenix Kalen, global head of emerging markets research at Societe Generale.

“Policy-makers are grappling with understanding the likely duration of the energy price shock.”

Interest rates have risen globally this year in response to the oil price surge resulting from the Iran war.

Euro zone inflation is at a three-year high of 4 per cent, above the ECB’s 2 per cent target. U.S. inflation has been above the Fed’s target for over five years.

“In the euro zone we see inflation back to target more quickly as we move through 2027 and so we would not be surprised if the ECB is cutting rates 12 months from now,” said RBC BlueBay fixed income CIO Mark Dowding.