The rising threat of interest rates staying higher-for-longer is likely to dent prospects of a soft landing for the US economy and drive a selloff in stocks over the next two months, according to Bank of America Corp. strategists.
The consensus probability of a hard landing is “around 20%,” but oil, dollar and bond yields remaining elevated, as well as tighter financial conditions, “remain the September-October risk,” strategists led by Michael Hartnett said in a note dated Sept. 7.
Hartnett and his team see a risk that recession and rising unemployment cause higher — rather than lower — long-term government bond yields, as markets discount fiscal policy panic and politicians spend to avert social and political unrest. The strategist correctly predicted the US stock slump last year, and has remained bearish in 2023 even as the S&P 500 rallied.
“Yields then rise to punishing levels,” causing a “long and hard landing,” Hartnett added. “We use any rallies in risk assets in coming months to get defensive” and position for a hard landing.
Rising bond yields are also making stocks unattractive, with the S&P 500 earnings yield of about 4.6% offering lower returns than the three-month Treasury bill yield of 5.5%. This negative gap of -0.9 percentage points is the lowest since 2000.
According to Hartnett, high positive gaps between earnings and bond yields have been extremely bullish for stocks and credit, citing March 2003, 2009 and 2020. By contrast, when the gap has turned negative, as in August 2000, or has narrowed to a low, like in July 2007, it has triggered “not so great” periods for these risk assets.
Equity markets have been rising this year on expectations that the economy will make a soft landing, while the Federal Reserve is seen to be nearly done hiking interest rates.
Still, cracks in the narrative started to appear, with Fed officials sticking to their hawkish stance, while 10-year Treasury yields surged to their highest level since 2007 in August. Meanwhile, rising oil prices, which have jumped about 24% since the end of June, are likely to keep some inflationary pressure.
Flows took another cautious turn in the past week, with money market funds attracting $68.4 billion inflow, the highest figure in nearly two months.
Since the start of the year, cash has already attracted $1 trillion in assets, according to EPFR. BofA private clients have also fled to money markets, with the largest inflows since March, and taking cash allocations to 11.7% of portfolios.
Other highlights from Bank of America:
- Global stock funds had inflows of $2.2 billion in the week through Sept. 6, according to the note, citing EPFR Global.
- Money market funds attracted $68.4 billion, their largest inflow in nine weeks, while $4 billion flowed into bonds.
- Tech funds saw their first outflow in 11 weeks at $1.7b.
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