AI and Oil Prices
At present, two factors are playing a major role in the financial markets: artificial intelligence (AI) and oil prices. Let us begin with the former.
The United States is currently experiencing a strong investment boom in projects and companies linked in some way to AI. In the view of many economists and analysts, this development is expected to have two major consequences:
- AI is widely expected to generate a substantial increase in productivity in the years ahead. Some analysts even foresee the possibility of significant structural unemployment as a result. Higher unemployment would likely place downward pressure on wage growth and inflation. In such an environment, the Federal Reserve would have considerable scope to stimulate the economy. This could eventually lead to a booming economy without excessive wage increases or inflationary pressure.
- Investor enthusiasm surrounding these prospects is reflected in the planned share issuance by Elon Musk’s company, which intends to build data centers and other AI-related infrastructure in space. These facilities require enormous amounts of energy, while space offers virtually unlimited access to solar power. Musk’s company, together with numerous others operating in this sector, is already being valued at several trillion dollars, with expectations of significantly higher valuations in the future. Part of this trend is the strong expansion in everything related to semiconductors, as data centers require massive quantities of chips.
Set against these highly positive long-term prospects, however, is a different short-term reality: a major economic stimulus effect and a sharp increase in demand for all materials and resources necessary for the construction of data centers. This includes, in particular, energy and semiconductors. This surge in demand is occurring precisely at a time when the Strait of Hormuz remains closed, resulting in significantly reduced supplies of oil, gas, and helium — the latter being essential for semiconductor production.
As long as the Strait of Hormuz remains closed, substantial price increases for these commodities can therefore be expected, leading to higher inflation, particularly in the United States, where economic growth is currently strongest.
It should also be noted that price increases have so far remained relatively moderate because inventories have been heavily depleted. However, this can only continue for a limited number of weeks before stocks are exhausted.
Against this backdrop, it is understandable that financial markets have recently responded positively to encouraging reports regarding negotiations between Iran and the United States. According to these reports, an agreement may be close, potentially leading to the reopening of the Strait of Hormuz in the near future.
Given the large volumes of oil and gas currently stored in vessels stranded in and around the Strait of Hormuz, such a reopening could quickly provide meaningful relief and gradually push oil and related commodity prices lower.
We emphasize the word “gradually.” Following recent events, many consumers of oil, gas, helium, and fertilizers are likely to increase their strategic inventories.
Nevertheless, the major inflation risk would largely disappear under such a scenario, allowing markets to refocus on the positive economic outlook associated with the adoption of AI technologies.
The key question is what all this means for the monetary policies of the Federal Reserve and other central banks, and consequently for interest rates. Naturally, much depends on future developments:
- If the Strait of Hormuz reopens soon, inflationary risks would ease, and the Federal Reserve would likely maintain a wait-and-see approach for some time. Short-term interest rates would probably remain largely unchanged in the near term. Only if oil and related commodity prices were to decline sharply could further rate cuts become likely, although this is not our base-case expectation.
With respect to long-term interest rates, several additional factors come into play. The U.S. economy has recently shown some signs of weakness, particularly among consumers. Should energy prices decline, these concerns would likely fade quickly. The labor market would remain tight, potentially leading to upward pressure on wages — or at least fears thereof.
Another important factor is that capital inflows into the United States from the Middle East and Asia are expected to remain subdued for the time being. At the same time, the U.S. government budget deficit remains excessively large, while financing conditions for AI-related investments are changing. Until recently, many of these investments could be financed internally, but increasingly they now require external borrowing.
For these reasons, we do not expect a reopening of the Strait of Hormuz to result in significantly lower long-term interest rates.
- Of course, it is also possible that the Strait of Hormuz remains closed, or only partially reopens, for an extended period. In that case, we would expect significantly higher commodity prices within weeks or months, leading to substantially greater inflationary risks. This would likely result in higher interest rates and a stronger U.S. dollar. Equity markets and gold prices, by contrast, would then come under considerable downward pressure.
This remains a scenario that should be taken seriously, particularly because Iran may have strategic incentives to maintain such pressure in the coming period. This could potentially extract additional concessions from the United States and Israel, even if it would be highly damaging to Iran’s own economy.
