Investors have recently been selling U.S. stocks at a rate that has not been witnessed in over nine months. Global equity funds experienced an outflow of $16.9 billion in the week leading up to Wednesday, marking the fastest weekly pace since December. This abrupt shift is primarily driven by concerns surrounding the potential for prolonged higher interest rates and its impact on the economy and risk assets, according to strategists at Bank of America Global Research.
Bleak Outlook for Economy with Elevated Interest Rates
In their latest weekly report, aptly titled the “Flow Show,” Bank of America’s team of strategists, led by Michael Hartnett, outlines their belief that global central banks are expected to maintain elevated interest rates, which increases the likelihood of a hard landing for the economy in the first half of 2024. They argue that the previous era of “lower-for-longer” rates and yields created bubbles and booms in the 2010s and 2020/21. However, the current scenario of “higher-for-longer” rates introduces significant risks, including potential bubble bursts and market downturns.
Hartnett and his team expressed their views in a Friday note, cautioning investors about the potential consequences of extended elevated rates. They emphasize that hard landing risks and bubble pops and busts are expected to emerge during the first half of 2024.
Central Banks Set to Maintain Interest Rates
Bank of America’s strategists extensively analyzed fund flows leading up to this week’s Federal Reserve policy meeting. During the meeting, policymakers decided to keep benchmark interest rates unchanged in the range of 5.25%-5.5%. However, their messaging explicitly conveyed that borrowing costs were likely to remain “higher for longer.” This shift was further substantiated by their revision of rate cut forecasts for the year 2024.
Bank of England Maintains Key Interest Rate
In addition to the Federal Reserve’s stance, the Bank of England chose to leave its key interest rate untouched for the first time since November 2021. This decision comes as inflation appears to be cooling down, and there are indications of the U.K.’s economy teetering on the brink of contraction.
Hartnett and his Team: Treasury Inflows and Bond Yields
In the week through September 20, investors bought $2.5 billion of Treasuries, marking the 32nd consecutive week of inflows, according to Hartnett and his team. During this time, Treasury yields continued to climb, reaching their highest levels in years.
Rising Yields and its Impact
According to Dow Jones Market Data, the 2-year rate (BX:TMUBMUSD02Y) carved out its highest level since July 18, 2006. Similarly, the 10-year rate (BX:TMUBMUSD10Y) rose to its highest level since October 18, 2007. The strategists at Bank of America (BofA) pointed out that earlier this summer, certain stocks, including the “Magnificent Seven” technology stocks, semiconductor-related stocks, and homebuilder stocks, had rallied back close to their highs in 2021 due to optimism about peak rates. Now, it is important to observe how these stocks react to the drop in bond yields.
The Outcome: “Bull5000” or “Bear4000”
Hartnett and his team suggest that if lower yields spark another rally in U.S. homebuilders and chipmakers, it could lead to a positive impact on the S&P 500 creating a “Bull5000” scenario. However, if these stocks fail to generate gains, it could result in a sell-off following the last rate hike, leading to a “Bear4000” situation.
Volatile Trading Week
As the trading week comes to a close, U.S. stocks are expected to experience steep losses. The S&P 500 (SPX) and Nasdaq Composite (COMP) are set to suffer from three consecutive weekly declines of approximately 2.8% and 3.5% respectively. The Dow Jones Industrial Average (DJIA) shows a decline of 1.7% for the week, according to FactSet data.