Market Matters- The AI rally meets an inflationary reality

• Markets began the week positively but lost momentum as inflation and bond yields reasserted themselves. AI-related enthusiasm supported equities early in the week, particularly across semiconductors, memory, cloud infrastructure and wider data-centre supply chains. However, stronger US inflation data and a sharp sell-off in global bonds prompted profit-taking after a strong rally. Japan was the best major market, up around 0.4%, while the S&P 500 was broadly flat. China was weakest, down around 2.4%, and bonds were also under pressure, with global aggregate bonds down c.0.9% and UK gilts down c.1.7%.
• The AI investment case remains intact, but valuations are now being tested. The trade is no longer limited to the Magnificent Seven, with investors increasingly focused on the broader supply chain, including semiconductors, high-bandwidth memory, networking, storage, cloud infrastructure and power equipment. Korea and Taiwan remain especially important through Samsung, SK Hynix and TSMC. Real earnings and capital spending continue to support the theme, but after a powerful rally, the price investors are willing to pay is now more sensitive to inflation and higher discount rates.
• US inflation was the key turning point, shifting the market narrative from growth optimism to policy constraint. Headline CPI rose to 3.8% year-on-year, while PPI was more concerning, with producer prices up 6.0% year-on-year, core PPI up 5.2%, and monthly PPI rising 1.4%. The issue is not just higher oil feeding into headline inflation, but the risk that energy, transport and freight costs start to pass through into food, goods, services and corporate margins. That makes the Iran/Hormuz shock inflationary first, with the growth drag likely to follow later.
• Bond markets reacted badly, reinforcing the risk that duration is not a clean hedge in an inflation shock. Yields rose across the US, UK, Japan and Europe, with the long end of curves under particular pressure. US 10-year yields moved toward 4.6%, while UK gilts sold off sharply and long-dated gilt yields reached levels not seen for decades. If oil stays elevated and central banks are forced to think about tighter policy rather than cuts, longer-duration bonds remain vulnerable. This is especially relevant for the UK, where fiscal and political uncertainty added to global bond pressure.

In summary? The near-term outlook remains constructive but more fragile than a week ago. Earnings momentum, AI capex and resilient US growth still provide support, and investors remain willing to buy market dips. However, risks have clearly risen: the Fed has less room to support markets, Europe remains exposed to the energy shock, China remains weak, and the Strait of Hormuz remains unresolved with Brent above $109. NVIDIA’s results are the next key catalyst, as markets look for confirmation that AI infrastructure demand remains strong enough to offset the more difficult inflation and bond-market backdrop.