Bank of America: The Federal Reserve's October interest rate hike will be the biggest bullish catalyst for the U.S. stock market

While global stock market investors are still shying away from the term "rate hike", Bank of America strategist Michael Hartnett has put forward a counter-intuitive judgment: If the Fed chooses to take the initiative to raise interest rates in October, this will not be negative at all, but may instead become the biggest positive factor supporting risk assets and underpinning the US stock market.

The root cause of the market's problems is not short-term interest rates

Generally speaking, the Fed's rate hike means monetary policy tightening, which is widely regarded as negative for risk assets.

However, the core of Hartnett's logic lies in: the most intractable problem facing the current market is not the short-term interest rate itself, but the continuous rise of the yield on US long-term Treasury bonds.

In the past week, the yield on 10-year US Treasury bonds once hit 5.36%, and the yield on 30-year US Treasury bonds even reached a new high since 2002. Amid widespread panic, the market has even started to discuss the possibility of the 10-year yield moving towards 6%.

In Hartnett's view, against the current background, if the Fed remains inactive for too long, bond investors will continue to demand higher term premium, pushing long-end yields further upward and eventually forcing the financial environment to tighten spontaneously.

Conversely, if the Fed takes the initiative to raise interest rates at the October interest rate meeting and sends a tough signal to curb inflation risks in advance, long-end yields are expected to stabilize. At that time, the short-term impact brought by the rate hike may be smaller than the greater damage caused by the disorderly fluctuation of the bond market.

Term premium is the core point of the game

The interest rate team of Bank of America pointed out that the main driver behind the recent rise in US Treasury yields is the combination of stronger US economic growth and higher term premium, rather than a substantial repricing of the market's expectation for the short-term federal funds rate.

The term premium refers to the additional risk compensation required by investors for holding long-term bonds — even if the market does not significantly raise its expectation for the Fed's short-term policy path, as long as long-term risk compensation is continuously demanded, US Treasury yields will keep rising.

This also explains why the Fed's dovish statements often fail to stabilize the bond market: if the economy remains strong, inflation risks remain high, and the central bank refuses to further tighten, the market will push up long-term financing costs in a disguised form by raising the term premium.

Based on this, Bank of America judges that once US economic data continues to be strong, the Fed has only two options: to take the initiative to raise interest rates, or to tolerate continued sell-offs in the bond market.

Under the circumstance of disorderly surge in long-end yields, the damage caused by active rate hikes will be even smaller.

Funding pressure lurks behind the resilience of the stock market

Despite the high level of US Treasury yields, the stock market has remained resilient recently: the major US stock indices are still hovering near historical highs, with an annual increase of about 13.4%; the South Korean stock market has surged nearly 100% all the way, and AI-related assets continue to strengthen.

However, in Hartnett's eyes, this resilience masks deeper funding pressures.

The South Korean market provides the clearest case: over the past 18 months, the yield on South Korean Treasury bonds has risen by about 200 basis points, Mirae Asset, the largest retail brokerage firm, has retreated by about 65% from its high point in May, but the broad market index has still risen by nearly 99%.

Hartnett's focus is on how leverage and duration risks will be exposed under the current global upward interest rate trend — the impact will not be reflected in the major stock indices first, but in the assets most sensitive to financing costs.

At present, the pressure has been transmitted to the weakest borrowers first: the spread of CCC-rated bonds has widened to 1200 basis points, the highest level since 2022. French sovereign bonds are also under pressure, and the spread with German bonds has widened to 140 basis points, which is the fastest expansion stage in at least two decades.

This shows that although the market has not yet determined that the economy will collapse, the financing environment for low-qualified entities has deteriorated significantly.

A decisive rate hike may be the "good medicine to rescue the market"

It is worth noting that the US stock market remaining at a high level does not mean that funds are willing to take risks.

EPFR data shows that in the week ending last Wednesday, about 1664 billion US dollars of global capital poured into cash-like assets, hitting the largest single-week inflow since April 2020; 33.8 billion US dollars flowed into bonds, and only 12.4 billion US dollars flowed into stocks.

The size of money market funds has approached 8 trillion US dollars, indicating that investors are voting with their feet and turning to defense.

Generally speaking, Hartnett judges that as long as the Fed's rate hike can reshape policy credibility, long-end yields are expected to stop rising endlessly; on the contrary, the bond market will continue to tighten the financial environment by pushing up yields.

In the eyes of this strategist, the real force to underpin the US stock market may not be the Fed's loose attitude, but a decisive and timely active rate hike.

This article is from the WeChat official account "CLS", author: Liu Rui, published with authorization from 36Kr.