BofA Warns of Scenario for Further Fed Rate Hikes

Strategists at Bank of America (BofA) have raised the possibility that the U.S. Federal Reserve could raise its benchmark rate above 5%, prompting market participants to adjust their investment strategies accordingly.

Since the Fed unanimously decided to raise rates last week, markets have priced in a greater than 50% chance of another hike next month. The Fed's dot plot also signaled one more rate increase this year. The rate swaps market expects the Fed to raise rates three more times, pushing the effective federal funds rate to 4.5–4.75%. BofA, by contrast, has suggested rates could exceed 5%, as they did when the Fed hiked 11 times to 5.5% between March 2022 and July 2023. However, in a note released on the 16th, BofA economists forecast that the Fed will hike rates again in October and December before holding them steady next year. The BofA strategy team led by Mark Cabana and Meghan Swiber said the market is underestimating the terminal rate and advised positioning for a rise in two-year Treasury yields.

Goldman Sachs, in a report released on the 16th, revised its forecast to expect a further 0.25 percentage point hike at the Fed's next move. Goldman Sachs analyzed that the Fed is more hawkish than expected, citing Fed Chair Kevin Warsh's characterization of the hike as a 'partial withdrawal of monetary accommodation.'

Ed Yardeni, president of Yardeni Research, cut his year-end S&P 500 target from 8,400 to 7,900. "Persistently high oil prices pose a risk of continuing to push up bond yields," he said, diagnosing last week's hike as the start of a hiking cycle. He noted that rising oil prices, combined with a strong economic recovery, increase the risk of inflation becoming entrenched.

Neel Kashkari, president of the Minneapolis Fed, said in an interview that inflation remains elevated even excluding volatile energy and food prices, adding, "The Fed's role is to bring inflation down to its 2% target." He voted for the rate hike at the Federal Open Market Committee (FOMC) meeting that ended on the 16th.

Michael Cuggino, chief investment officer (CIO) at Principal Asset Management, said in an interview with Yahoo Finance on the 20th (local time), "This rate hike may not end after just one or two rounds," diagnosing that "if the Fed aims to firmly curb demand, tightening could be far more aggressive than expected."