The U.S. 10-year real bond yield, widely used as the discount rate for global equities, has climbed 80 basis points since February to a cycle high of 2.5%, according to BofA Securities.
BofA attributes the move to several concurrent forces. Global growth momentum has firmed - marked by the global purchasing managers' index reaching a three-year high in August - while the U.S. labor market has shown improvement and inflation risks have edged up. Those macro forces have helped push real yields higher as investors price in a more hawkish Federal Reserve stance.
Geopolitical developments have compounded the pressure on markets. A renewed escalation in the Middle East has lifted oil back above $100 a barrel and added fresh stress to already strained supply chains, the broker noted. Commodity and logistics pressures have therefore joined the growth- and labor-driven forces behind higher yields.
Equities initially absorbed the upward shift in rates largely because of two offsetting factors: falling equity risk premia and a strong corporate earnings cycle. That combination provided a cushion even as real yields rose. But BofA says that cushion has started to thin.
European equities have shown signs of vulnerability. The Stoxx 600 has dropped almost 4% since mid-August as the ongoing rise in rates has ceased to be offset by declining equity risk premia, and the earnings upgrade cycle has begun to cool. In short, the earlier resilience in equity markets is showing strain as rate pressures persist.
Consensus among market participants still leans toward higher bond yields, but BofA's rates strategists flag a plausible countervailing path. They see scope for the U.S. 10-year nominal yield to fade back to about 4.5% by year-end. The broker sets out several reasons for that view:
- The market is already pricing in three Federal Reserve rate hikes by mid-2027.
- Inflation momentum is not uniformly strong; the three-month annualized Consumer Price Index is running close to a five-year low of 1.6%.
- A sharp rates sell-off that feeds through to equity weakness could prove self-limiting, because the resulting tightening of financial conditions would likely reduce the Fed's incentive to stay hawkish.
- Positioning in rates markets is already short, which raises the potential for a rally in bonds and a decline in yields if positions are unwound.
Those factors, BofA argues, mean that while yields have room to rise further under some scenarios, there are credible mechanisms that could push the 10-year yield lower before the year ends.
Outlook - The interaction between growth signals, inflation dynamics and financial conditions will determine whether real and nominal yields keep climbing or reverse course. Market participants must weigh the current macro momentum and geopolitical risks against indicators of weakening inflation momentum and crowded short positions in rates markets.