Bank of America Warns that High Interest Rates May Pose a Risk for the Stock Market

After a tumultuous year in 2022, where stocks plummeted as the Federal Reserve raised interest rates, the stock market has experienced a strong rebound in 2023. However, analysts at Bank of America are cautioning investors that it might be time to start worrying again.

In a note to clients on Tuesday, Bank of America analysts highlighted that high interest rates could re-emerge as a threat to the stock market, even as investors anticipate a loosening of monetary policy in the first quarter of next year. They believe that the risk of high rates is currently underpriced by the equity market.

Stocks have rallied significantly this year, with the S&P 500 surging nearly 18% year-to-date. This strong performance has been fueled by advancements in artificial intelligence, cooling inflation, and diminishing recession odds. However, Bank of America analysts emphasized that the market’s sensitivity to rates seemed to weaken this year, until recently.

They highlighted that higher yields were a major driver of the S&P 500’s downside in 2022. When interest rates climb, fixed-income assets like bonds become more attractive relative to stocks, as they offer higher returns with lower risk. The correlation between the S&P 500 and 10-year US Treasury yields recently reached its lowest level in 23 years.

The Federal Reserve has implemented a tightening campaign over the past 17 months, raising interest rates by 525 basis points in an effort to combat inflation. Despite positive economic data and predictions of solid growth, Bank of America warns that if recession concerns continue to fade and fears of inflation or a tighter-than-expected Federal Reserve return, there is a risk that higher rates will once again become a headwind for stocks.

Investors should keep a close eye on interest rates as they have the potential to significantly impact the stock market. While this year has seen a remarkable recovery, it is important to remain vigilant and assess the potential risks, particularly as monetary policy begins to shift. Bank of America’s warning serves as a reminder that the stock market is not immune to the impact of interest rate fluctuations.