This is how yields could turn supportive for equities again

Investing.com -- Bank of America said in a new note to clients that falling real bond yields could turn from a headwind into support for equities, though it remains negative on European stocks.

European equities have been flat since the outbreak of the U.S.-Iran war despite accelerating growth, the bank noted, highlighting that the global PMI is on track to reach about 54.5 in September, the strongest reading since 2018 excluding the pandemic.

That strength, alongside above-target inflation, an improving U.S. labor market and rising energy prices, has pushed the Fed and the European Central Bank back into tightening mode, said BofA.

The resulting rise in U.S. 10-year real yields has offset a 13% surge in forward earnings estimates for the Stoxx 600.

“BofA's macro analysts are not extrapolating the recent strengthening in growth,” the bank wrote. “They also see downside for oil and no real further acceleration in US jobs growth, leading them to expect inflation to flatline in the near term before renewed disinflation.”

As a result, they expect only short hiking cycles, with a further 50 basis points from the Fed and 25 from the ECB. That would be significantly more dovish than the 80 to 90 basis points markets have priced in.

The bank's rates strategists see about 25 basis points of downside for the U.S. 10-year real yield by year-end.

“We remain negative on European equities and underweight cyclicals versus defensives,” said BofA. “Historically low levels of the ERP do not provide adequate compensation for the risks around the AI buildout, energy supplies and default rates, leading us to expect the ERP to rise, translating into nearly 10% further downside for the Stoxx 600 and further underperformance for cyclicals versus defensives.”

Original Article

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