Bank of America Warns Interest Rates May Soar Above 5%

Bank of America has warned that interest rates could rise above 5% in response to further Federal Reserve rate hikes. According to Bank of America strategists, the market underestimates the endpoint of this round of rate hikes, which began this week. The team led by Mark Cabana and Meghan Swiber believes overnight borrowing costs could return to peak levels seen during the 2022-2023 tightening cycle, when the target rate reached as high as 5.5%. They forecast that the yield on the two-year U.S. Treasury note will rise to 5% by year-end.

The Bank of America team noted that Chairman Kevin Warsh's remark suggests officials do not yet believe monetary policy is weighing on the U.S. economy. A Federal Reserve that does not view policy as restrictive may keep raising rates until financial conditions become genuinely restrictive, reinforcing their conviction that the yield curve will flatten.

The strategists advise clients to short the two-year U.S. Treasury bond with a target yield of 5.25%, roughly the peak level seen in 2023. They also pointed out that officials see upside risks to inflation as far greater than risks to unemployment, citing a calculation based on the Taylor rule which suggests the federal funds rate should be around 5.3%.