A few weeks ago, I wrote about a group of people standing in a dark room, each holding a pin, none of them knowing whose hand would find the balloon first. I think I can now name one of the pins. It is called a rate hike.
This is not a small, one-line risk. It sits at the intersection of everything I have been tracking this month: India’s stickier-than-expected inflation, America’s own hawkish undertone, a US political calendar that could remove the last source of pressure on the Fed to go easy, and an AI investment cycle that has been priced for perfection. Put these together, and I think the probability of a rate-hike-triggered correction is higher than most portfolios are prepared for — even though I continue to believe that the longer-run destination for global monetary policy is easier money, not tighter.
Inflation is not cooling the way we hoped
India: a stall, not a reversal
July’s CPI print came in at 4.45% year-on-year, above where most estimates had it pegged, and above June’s 4.38%. Food inflation is running hot at 5.5%, durable food inflation has climbed to 5.1%, and even core inflation — stripping out food and fuel — is holding near 3.9%, with the ‘super-core’ reading (core excluding gold and silver) creeping up to 2.5%. None of these numbers is alarming in isolation. Together, they tell me the disinflation trend of the past year has stalled, not reversed, but stalled at a level still uncomfortably close to the upper end of the RBI’s comfort zone.
My own base case is FY27 CPI inflation averaging around 5%, with a genuine risk of topping 5.5% if the monsoon turns uneven in its closing weeks or crude prices find a bid again. On that math, it would not be unreasonable to expect ~50bps of cumulative tightening in 2HFY27 — a meaningful shift from a market that has spent most of this year debating rate cuts, not hikes.
The US: a hawkish Fed the market isn’t pricing in
The view that the Federal Reserve may hike interest rates by 50-75bps points before this year is out is strengthening gradually, against a Fed Funds futures market that is currently pricing in barely 25 basis points of hikes. That is a large gap between what I think is coming and what the market has actually priced in — and gaps of that size tend to close abruptly, not gradually, once the data forces the market to catch up.
In my view, successful policy needs many conditions to align at once — growth, inflation, credibility, fiscal discipline — while failure can come from any single one going wrong. Right now, resilient growth and sticky inflation are both arguing against the rate cuts the market has been hoping for, which is why my own reading of US rates and the dollar stays firmly on the hawkish side for the next two to three quarters, not the dovish one.
The political overlay nobody wants to say out loud
If the Republicans lose ground in this year’s US midterm elections, the Trump administration effectively becomes a lame-duck presidency for its remaining term. A weakened White House has historically had less leverage — political or otherwise — to lean on the Federal Reserve to keep money cheap. Whatever informal pressure exists today to ease policy in an election-conscious environment would diminish sharply once the electoral calculus behind such pressure disappears.
That matters because a Fed chair with a hawkish reputation, freed from midterm-related political pressure, has every incentive to hold the line on rates for longer than the market currently expects — partly on principle, partly to protect their own legacy. The direction of travel over the medium term may still be lower rates, for reasons I laid out a few weeks ago, but the road between here and there could run through more tightening first, not less.
Why a hike could pop the AI balloon faster than anyone expects
This is where the rate-hike story stops being an isolated macro debate and starts becoming a market-structure problem. Ruchir Sharma and Michael Burry, among others, have separately warned that if US rates move higher from here, the unwind of AI-linked positioning could be sharper and faster than currently priced. I think the underlying numbers explain why that warning has teeth. The RIC report by BoFA strategist digs deeper:
● Capex without proof of productivity. AI capital expenditure is sitting at record highs relative to sales, while economy-wide productivity growth is running at just about 2.2% — barely above the roughly 2% average this economy has managed since 1987. By my own read, AI’s actual contribution to that number is only about 0.1 percentage point a year, a fraction of what the dot-com capex cycle delivered relative to its own spending. That is a very large bet resting on a very thin evidence base.
● A crowded, one-way trade. Fund manager surveys consistently show semiconductors as the single most crowded trade in the market, cited by well over three-quarters of respondents, even after brief rotations toward defensives. Crowded trades unwind violently precisely because everyone is trying to exit through the same door at the same time.
● Concentration risk in the index itself. The ten largest companies in the US market now represent more than $24 trillion, or roughly a third of the broad index. When an index is this concentrated, a reversal in mega-cap leadership does not stay contained to a sector — it drags the benchmark, and every fund benchmarked to it, down with it.
● A discount-rate problem. AI and other long-duration growth stocks are priced on cash flows expected many years out. Higher rates mechanically shrink the present value of those distant cash flows more than they shrink the value of a bank or an energy company earning cash today. A rate hike does not just raise the cost of capital for AI companies — it re-prices the entire long-duration growth complex at once.
None of this means AI itself is a mirage. There are real, if narrow, productivity gains showing up in areas like software development, and history shows that transformative technologies — railroads, fibre-optic cable, shale — usually do create genuine value eventually, even when the first wave of capital that funds them is destroyed along the way. The risk is not that AI fails as a technology. The risk is that AI-linked equity valuations are pricing in a smooth, uninterrupted path to that value creation, and a rate shock is exactly the kind of event that interrupts smooth paths.
Reconciling this with my ‘more QE eventually’ view
Regular readers will remember that I have also argued the opposite-sounding case: that America’s over-levered household sector, its habit of rolling short-dated Treasury debt, and a banking system running low on reserves all point toward more monetary easing eventually — potentially a ‘super QE’ larger than 2008 or 2020. I still believe that. The two views are not actually in conflict; they describe two different points on the same timeline.
“What’s much less certain is what happens in the interval between ‘everyone knows QE is coming’ and ‘QE actually arrives.’ That gap is where currency stress, bond-market air pockets, and credit events tend to live.”
A rate hike in late 2026 or early 2027 would not contradict the eventual-easing thesis — it would be the disorderly middle chapter that forces the eventual easing to happen.
Higher rates now would be deflationary in their immediate effect: they would raise the cost of AI-related capex, slow the investment momentum that has been propping up GDP growth, and puncture the wealth effect that has kept US consumption resilient even as real household finances have deteriorated. That combination — weaker growth, a wounded wealth effect, and credit stress already visible in pockets of leveraged loans and private credit — is precisely the kind of shock that eventually forces a central bank’s hand toward emergency easing. The path there, though, could be considerably more painful.
Strategy
Indian Equity: Cut to underweight; trim froth. Nifty offers only moderate upside on my own math, and valuations are rich, so macro risk (rate hike + global AI shakeout) argues for buying dips, not chasing rallies. Reduce high-beta, high-PE, story-driven names; favor quality, cash-generative large-caps and domestic-demand plays over globally-linked cyclicals.
Global Equity: Cut exposure. Reduce concentration. Prefer diversified international and value-tilted funds over concentrated AI-themed funds.
Debt/Fixed Income: Rising rates hurt long-dated bonds first and hardest. Prefer accrual, short duration and high-quality corporate paper over long gilts.
Cash/Liquid Funds: Overweight. Keep dry powder to redeploy if the ‘gap’ between hawkish talk and eventual policy easing turns disorderly. Liquid and ultra-short funds, not idle savings accounts.
(Note: I am not considering gold and cryptocurrencies in my strategy as my understanding of these assets is extremely poor. Each investor may consider these as per his\her understanding.)
The bottom line
The probability of a rate hike — in India, and more importantly in the US — is higher today than the market’s own pricing suggests. If that hike arrives while AI-linked valuations remain this stretched and this concentrated, the resulting correction could be faster and sharper than the consensus ‘soft landing, gentle AI cooldown’ narrative currently assumes. I do not think this changes the eventual destination — a more accommodative monetary regime once the strain becomes visible enough to force policymakers’ hands. But the road between here and there is the part investors actually have to live through, and it is worth positioning your portfolio for a bumpier middle chapter: equity that leans toward quality and away from crowded themes, debt that stays short in duration; and adequate dry powder (cash).
As always, I could be wrong about the timing, the trigger, or the severity — markets have a way of staying irrational for longer than any single argument accounts for. But positioning for a plausible, non-trivial risk is not the same as predicting it, and that distinction is the whole point of risk management.