Markets face 'sharp correction' if mood sours on AI or Fed freedom, Bank of England says

Group 1 - The Bank of England (BoE) warns that global financial markets could face significant downturns if investor sentiment regarding artificial intelligence (AI) or the independence of the U.S. Federal Reserve deteriorates [1][2] - The BoE's Financial Policy Committee (FPC) highlights an increased risk of a sharp market correction, particularly due to potential AI-related market declines, which could have material spillover effects on the British financial system [2][3] - Concerns are raised about the potential loss of Federal Reserve independence, which could lead to a sudden change in perceptions of its credibility, resulting in increased volatility and risk premiums in U.S. dollar assets [3] Group 2 - British government borrowing costs are closely linked to U.S. Treasury yields, indicating that a decline in U.S. bond prices could raise the cost of servicing new British public debt [4] - The BoE notes that the increase in borrowing costs reflects challenges in managing high debt levels across advanced economies, exacerbated by political uncertainties in France and Japan [5] Group 3 - The BoE points out that 30% of the U.S. S&P 500's valuation is concentrated in the five largest companies, marking the highest concentration in 50 years, with significant investments in AI from companies like Nvidia, Microsoft, Apple, Google-parent Alphabet, Amazon, and Facebook-parent Meta [6] - Current share valuations based on past earnings are reported to be the most stretched since the dotcom bubble, although they appear less stretched when considering future profit expectations [6][7] - The increasing concentration within market indices makes markets particularly vulnerable if expectations regarding AI's impact become less optimistic [7]