Citi: Markets begin pricing in a slowdown in AI investment as Fed rate path faces uncertainty
Citi interprets falling stock prices, widening credit spreads and declining Treasury yields as signs that markets are assigning a higher probability to a slowdown in AI spending. The bank still expects a rate hike in December, but the buffers provided by consumption and housing are weakening, and further stock market declines could change the policy direction.
Original source：Citi ResearchFirst published on Unhidea：Original source date：
Key takeaway
Citi believes US growth’s reliance on AI investment gives a stock market correction greater macroeconomic consequences: it could depress both investment and consumption, and could also prompt the Federal Reserve to abandon its next rate hike and shift to cuts.
Why are markets starting to worry about a slowdown in AI investment?
This week, stock prices fell, credit spreads widened and Treasury yields declined. Citi interprets these moves as a sign that markets are assigning a higher probability to a slowdown in AI spending, and that uncertainty about the growth outlook is affecting asset prices.
The key threshold is whether returns on AI investment can cover financing costs. Over the past two years, AI-related investment has contributed an important part of US GDP growth; if concerns about returns cause investment to slow or even fall, US growth will lose an important source of support.
Citi previously attributed rising long-term Treasury yields primarily to expectations of strong growth and a more hawkish central bank response. Weaker growth expectations now also reduce the market’s assessment of the central bank’s willingness to keep raising rates, so falling yields and widening credit spreads can occur at the same time.
Why are there still concerns about growth when third-quarter GDP is expected to accelerate?
Citi expects real GDP to grow at an annualized quarter-on-quarter rate of 3.1% in the third quarter, above the second quarter’s 2.2% and slightly above the market consensus of 3.0%. But year-on-year growth is expected to fall to 2.0% because growth was stronger in the third quarter of last year; the quarter-on-quarter acceleration and year-on-year slowdown reflect different comparison bases.
Investment demand remains strong: the bank expects equipment investment to grow at an annualized quarter-on-quarter rate of more than 20% in the third quarter. However, computers, electronic products and other goods needed for AI rely heavily on imports, so not all of the increase in purchases translates into US domestic production, and net exports will weigh on GDP.
Inventories are expected to contribute about 2 percentage points, partly offsetting the drag from imports. The overall forecast of 3.1% should therefore be understood alongside investment, imports and inventories; trade data released before GDP could still change the bank’s growth estimate.
Can consumption and housing cushion a slowdown in investment?
Consumption remains resilient for now, but income support is weak. Citi expects nominal spending to rise 0.6% month on month in September, bringing the already low savings rate down further; persistently weak growth in real wage income would gradually constrain spending.
Retail sales already reported for September rose 0.8% month on month, partly due to higher gasoline prices; retail control group sales rose only 0.1%, indicating a more moderate underlying consumption trend. Citi also judges that a further stock market decline would depress consumption.
Housing has already been hit by high interest rates: the 30-year mortgage rate reached 7.5%, while pending home sales, single-family building permits and mortgage applications for home purchases all fell rapidly. If rates remain at this level, Citi expects home prices could move from year-on-year growth of 1%–3% this year to broadly flat in 2027.
Under what conditions would the Fed shift from rate hikes to cuts?
Citi’s baseline path remains a 25 basis-point hike in September, a pause on 28 October, and another 25 basis-point hike in December, taking the policy rate range to 4.0%–4.25%.
Inflation continues to constrain policy easing. The bank expects core PCE to rise 0.31% month on month and 3.1% year on year in September, with price pressures remaining relatively strong; resilient growth and elevated inflation together support its expectation of a rate hike in December.
Further stock market declines are the condition that could change the path. If their impact on investment, consumption and growth intensifies, Citi believes the Fed’s next move could be a rate cut. When GDP and PCE data are released next week, the bank expects markets to be more sensitive to growth falling short of expectations, because earlier CPI and PPI data have already revealed most of the information about core PCE.
