The persistent climb in US long-term bond yields is pressuring the bond market, with a top strategist at Bank of America suggesting that a single "panic rate hike" might be the remedy the market needs.
The real yield on the US 30-year Treasury bond has risen to 3%, marking its highest level since the global financial crisis in November 2008. In his latest strategy report, Bank of America's Chief Investment Strategist Michael Hartnett argues that the incoming Fed Chair, Walsh, may need to implement a rate increase to stabilize the long end of the yield curve.
Currently, the market assigns a 38% probability of a rate hike at the next Fed meeting, and has fully priced in a rate increase for the meeting on September 16th.
However, this outlook faces political constraints. Hartnett notes that a key variable before the November midterm elections is whether the Trump administration, which he describes as "equity-friendly," will tolerate a rate hike that could act as a brake on the stock market.
The tightening of financial conditions is already underway—23 central banks globally have raised rates so far this year, and Bank of America expects another 18 before year-end. Concurrently, the ongoing expansion of AI capital expenditure is causing the cash flow of many S&P 500 components to turn negative, which implies that future stock buybacks will correspondingly shrink.
Hartnett currently recommends investors pivot toward defensive sectors and long-duration assets, while avoiding banks, technology, and industrial stocks.
Real long-term bond yields hit a 16-year high, as bond market pressure continues to build
The real yield on the 30-year US Treasury reaching 3% is not only a direct representation of tightening financial conditions but also places systemic pressure on the valuations of risk assets.
Hartnett believes that for the market to shift its focus from the negative impact of tighter financial conditions to the positive factors of earnings growth, a rate hike under Walsh's leadership at the Fed is necessary.
Walsh has previously abandoned the Fed's forward guidance, and Hartnett points out that the current inflation environment does not support inaction: the annual growth rate of the Consumer Price Index (CPI) remains in the 3% to 4% range, and the labor market shows no signs of disruption from AI.
Political pressure is the biggest constraint on rate hikes, but tighter financial conditions are already a reality
Hartnett states directly that regardless of the negotiations between Walsh and the government, the trend of tightening financial conditions is unavoidable.
Central banks worldwide have already executed 23 rate cuts this year, with Bank of America expecting 18 more before the end of the year. Against this backdrop, the probability of Walsh being forced to respond to bond market pressure is rising, although the "equity-friendly" policy orientation may complicate the timing of any rate hike.
Current market pricing shows a 38% probability of a rate hike at the next Fed meeting, but it has been fully priced in for the meeting by September 16th.
This distribution of expectations reflects the market's internal conflict regarding the policy path—caught between fears of rising inflation and yields, and concerns about the impact of policy tightening on the stock market.
The correlation between rising yields and bank stocks may reverse, triggering deleveraging in risk assets
Hartnett notes that the recent market has seen a pattern of rising bond yields coinciding with gains in bank stocks, but he warns that this relationship could reverse—whereby higher yields instead depress bank stocks, triggering a wave of deleveraging across risk assets.
In response, he views the US dollar as the best hedging tool. Theoretically, higher interest rates would widen the yield differential between the US and other markets, attracting capital flows into US Treasuries and supporting a stronger dollar.
Semiconductor stocks have fallen over 20% from their June high. Hartnett views "blue-collar" semiconductor companies like Texas Instruments, Analog Devices, NXP, Microchip, ON Semiconductor, and STMicroelectronics as leading indicators for the industrial cycle—specifically, as a bellwether for the AI industry cycle.
Based on this assessment, Hartnett and his team—Jessica Guo, Anya Shelekhin, and Myung-Jee Jung—recommend overweighting defensive sectors, dividend assets, and long-duration bonds, while underweighting banks, brokerages, technology, and industrial stocks.
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