The Fed could pop the AI bubble, and investors shouldn't chase the hype as financial conditions tighten, Bank of America says

• The Fed could pop the AI bubble in stocks, and investors shouldn't chase the hype, Bank of America said.
• That's because financial conditions are tight, a factor that's burst Wall Street's excitement in the past.

The Federal Reserve could pop the artificial intelligence bubble in stocks, and investors shouldn't chase the craze as financial conditions are set to stay tight, according to Bank of America.

In a note on Friday, the bank's investment strategists pointed to Wall Street's excitement for artificial intelligence, with even obscure AI stocks soaring in recent months on investors' enthusiasm for the sector.

According to the bank, the "baby bubble" in AI stocks will likely last only until the Fed raises interest rates another 100-150 basis-points.

"But don't chase here… financial conditions are tightening again," strategists warned, pointing to previous stock market fads that were burst as financial conditions grew tighter. In previous eras this was seen in the early 2000s dot-com bubble, the 2008 subprime mortgage crisis, and the crypto rout in recent years, as high rates squeezed speculation out of the market and weighed heavily on risk assets.

Interest rates are now the highest they've been since 2007, with central bankers having raised rates 500 basis points in the past year to tame inflation – and the Fed has warned rates will stay high through the rest of 2023 as inflation is still elevated.

And though investors have bet on the Fed pausing or soon pivoting from its rate hikes, the central bank will likely raise rates higher, the BofA strategists said in a previous note. Though headline inflation has come from a 41-year-record notched in 2022, core inflation is still accelerating, which suggests the Fed has more tightening to do in order to battle price pressures in the economy.

Central bankers are set to discuss their next policy move on June 13-14. Markets have priced in a 59% chance that the Fed will raise interest rates another 25 basis-points, which would lift the Fed funds rate target to 5.25-5.5%.