Overview
Bank of America strategists have laid out a case for the Federal Reserve to start trimming policy accommodation as soon as September, citing underlying inflation pressures above target, reduced downside risks to the labour market, and a perceived incentive for Fed Chair Kevin Warsh to tighten policy. BofA's central forecast is for 75 basis points of tightening across the remainder of the year, delivered as three 25-basis-point moves at each of the scheduled meetings through December.
Market pricing versus BofA projections
Market-implied odds for a hike in September remain modest by BofA's standards, with pricing roughly at 15 basis points for that meeting even after what the bank calls a hawkish pivot by Warsh at Jackson Hole last week. More broadly, the market's implied total tightening by December sits about 40 basis points below BofA's 75-basis-point projection.
Implications for bond yields and equities
BofA highlights the sensitivity of global equity valuations to U.S. real bond yields, noting that those yields function as the discount rate for equities worldwide and move closely with Fed policy expectations. The bank points out that a roughly 10-basis-point increase in the U.S. 10-year real yield over the past week accounts for the entirety of the STOXX 600 fall observed during that period.
A September rate move from the Fed, the strategists say, would likely put additional upside pressure on bond yields. Higher yields would in turn act as a headwind to equity multiples.
Sector impacts
BofA's sector analysis indicates that a hawkish repricing raising U.S. real yields would disadvantage sectors with negative sensitivity to higher rates. Semiconductors, personal and household goods, and utilities are singled out as facing the largest headwinds under that scenario. Conversely, airlines, banks and energy are identified as the sectors likely to reap the most support from such a move.
Positioning on European equities and cyclicals
The bank stays negative on European equities overall and prefers defensives over cyclicals. BofA describes a meaningful hawkish repricing toward its economists' Fed projections as a credible bear case for European equities, noting that cyclicals would be particularly exposed.
Contrasting view from rates strategists
At the same time, BofA's rates strategists have begun to position for an alternative path in which bond yields decline again. They cite signs of softening near-term inflation momentum and weak U.S. jobs and consumer data as the rationale for this view. In that base-case scenario of a mild decline in yields, equities would receive a tailwind, all else equal.
Risk premia and downside scenarios
The firm also highlights room for risk premia to widen from historically low levels, pointing to several risks it says could push premia higher: potential disappointment in AI-related capital expenditure, continued weak U.S. jobs growth, and energy-supply disruptions tied to the U.S.-Iran war. Under the bank's macro assumptions, these dynamics amount to about a 10% downside for the Stoxx 600, to a level of 580 by the second quarter, along with roughly 5% additional underperformance for cyclicals versus defensives.
Preferred sector tilts
Reflecting its defensive stance, BofA prefers an overweight in food and beverages. Among cyclicals, the bank favours underweights in banks and capital goods.