Bank of America: Peak in Real Yields Could Soon Support Equities

A recent surge in real bond yields has acted as a significant headwind for equities, but this trend could be poised to reverse, according to a new client note from Bank of America. While the bank's strategists see potential support for stocks from falling yields, they remain negative on the outlook for European equities.

The Yield Headwind

Bank of America noted that strong economic data, including a global PMI reading on track for its highest level since 2018 (excluding the pandemic), has prompted the Federal Reserve and European Central Bank to resume monetary tightening. This policy shift has pushed U.S. 10-year real yields higher.

The impact has been particularly visible in Europe, where the rise in real yields has completely offset a 13% surge in forward earnings estimates for the Stoxx 600 index, leaving the market flat.

A More Dovish Outlook

However, BofA’s macro analysts hold a more dovish view than the market consensus. They do not expect the recent strength in economic growth to be sustained and anticipate a decline in oil prices and a stabilization in U.S. jobs growth. This leads them to forecast that inflation will level off before disinflation resumes.

As a result, the bank projects shorter central bank hiking cycles than currently priced in by markets:

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• Federal Reserve: A further 50 basis points of hikes.
• European Central Bank: A further 25 basis points of hikes.

This forecast is significantly below the 80 to 90 basis points of tightening that markets have priced in, according to the note.

Investor Implications

Based on this macro outlook, Bank of America's rates strategists forecast a 25 basis point decline for the U.S. 10-year real yield by the end of the year. This shift could turn yields from a drag into a source of support for equities.

Despite this potential tailwind, the bank remains negative on European stocks and maintains an underweight on cyclical sectors versus defensives. Analysts argue that the equity risk premium (ERP) is at historically low levels and does not adequately compensate for risks related to AI infrastructure, energy supplies, and default rates. They expect the ERP to rise, which could translate into nearly 10% further downside for the Stoxx 600 index.