Do you remember the massive U.S. stock market tremor caused by the "AI ghost story"? The originator has spoken again.

Earlier this year, Citrini Research founder James van Geelen published a 7,000-word “AI (Artificial Story) Ghost Story,” which unexpectedly triggered a sharp decline in the US stock market. Now, he is sounding the alarm again: under the US-Iran conflict, US stocks will continue to fall, and the market should not give up on rate cut bets!

US stocks still need to fall

On Wednesday, van Geelen warned on Substack that an economic slowdown caused by soaring oil prices could lead to a stock market decline. He explained that persistently high energy prices might pressure consumers and corporate profits, and even if the Federal Reserve eventually cuts rates, the stock market will struggle.

“If the war doesn’t end, the stock market will decline,” he wrote. He also emphasized that geopolitical tensions are the key driver behind the sustained rise in oil prices.

Van Geelen’s core argument is that high oil prices act like a tax on economic growth, weakening purchasing power and tightening financial conditions, and that the Fed doesn’t need to take further action. He believes that, given policy rates are already near neutral, maintaining rates is sufficient to contain the impact as energy shocks gradually permeate the economy.

He wrote, “We are now in a different world, with interest rates near neutral. If oil prices stay high, even keeping rates at current levels will be enough to impose restrictions because rising oil prices will spill over into other parts of the economy, leading to a slowdown.”

Van Geelen further stated that this dynamic makes stocks particularly vulnerable. Even if geopolitical tensions ease quickly, there is limited room for stocks to rise. He pointed out that after digesting higher fuel costs, consumer spending will still “slightly decline,” which will dampen any rebound.

Citrini’s latest view also challenges the common bullish narrative that rate cuts will support stocks. Van Geelen believes that any eventual easing policy may be aimed at countering slowing economic growth, which historically often leads to further declines in the stock market rather than sustained rises.

Don’t give up on rate cut bets

Van Geelen noted that the surge in oil prices caused by President Trump’s attack on Iran increases the risk of a shock similar to the 1970s, which would force central banks worldwide to raise interest rates to prevent runaway inflation.

This, in turn, led to a sharp decline in global bond prices. In the US, as traders abandoned expectations of rate cuts, US Treasury prices saw their biggest drop since October 2024, when markets had anticipated Trump’s election would boost the already strong economy.

Before the outbreak of the Middle East conflict, according to CME FedWatch tools, markets expected at least two rate cuts this year, with nearly a 40% chance of larger easing. However, with rising oil prices, this expectation has completely reversed—markets now expect rates to stay unchanged this year, with an 18% chance of rate hikes.

However, van Geelen believes that the surge in oil prices is likely to cause new, sufficiently severe shocks to the economy, preventing the Fed from raising rates. He predicts the Fed will ignore the impact of the oil crisis and is unlikely to hike.

He thinks that if the war is resolved within a month, “consumers will be slightly weakened,” but inflation concerns will fade. If the war continues, he forecasts stock prices will fall, “the wealth effect will cause the market to weaken to the point where the Fed cannot afford to keep rates unchanged for the next 12 months.”

He stated that his firm is long three-month futures contracts on the secured overnight financing rate and short US stocks. If the economy suffers a heavy blow, both bets will profit.

(Source: Caixin)