Fed Hike in September Could Drive 10% Decline in European Stocks, BofA Warns

A potential U.S. Federal Reserve interest rate hike in September could trigger a significant downturn for European stocks, according to strategists at Bank of America. The bank's analysis outlines a plausible bear scenario where a hawkish Fed policy weighs on equity valuations across the continent.

The Case for a Hawkish Fed

Bank of America's base case calls for a total of 75 basis points in Fed hikes for the remainder of the year, beginning with a 25-basis-point increase in September. In a note to clients, strategists cited above-target underlying inflation and a resilient labor market as key reasons for their forecast.

The bank's projection is significantly more aggressive than current market sentiment. According to the note, market pricing implies only a 15-basis-point hike in September and is roughly 40 basis points below BofA's 75-basis-point forecast for the full year.

Impact on European Equities

A Fed hike would likely put upward pressure on U.S. 10-year real bond yields, which serve as a critical discount rate for valuing global equities. Higher yields typically translate to lower stock multiples. The strategists noted that a recent 10-basis-point rise in the U.S. 10-year real yield "explains all of the STOXX 600 decline seen over the period."

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Under this hawkish scenario, BofA's macro assumptions imply approximately 10% downside for the Stoxx 600 index, with a target of 580 by the second quarter. The bank also anticipates that cyclical stocks could underperform defensive stocks by an additional 5%.

Sector Winners and Losers

A hawkish Fed repricing would have varied effects across different industries, according to the analysis. Rate-sensitive sectors would face the most significant headwinds, while others could benefit.

• Sectors Facing Headwinds: Semiconductors, personal and household goods, and utilities.
• Sectors Receiving Support: Airlines, banks, and energy.

Reflecting this outlook, BofA remains negative on European equities overall, recommending an underweight position in cyclicals versus defensives. The firm's preferred defensive overweight is food and beverages, while it holds underweights in banks and capital goods.