BofA Warns Investors: Fed May Push Rates Above 5%

Bank of America (BofA) strategists have warned investors that they should be prepared for the possibility that the Federal Reserve raises its benchmark interest rate above 5%. In a report, Mark Cabana and Meghan Swiber projected that the Fed could lift its policy rate back to levels seen during the 2022-2023 tightening cycle, when the upper bound reached as high as 5.5%.

The current market prices in three more Fed increases, which would bring the effective federal funds rate to between 4.5% and 4.75%. The two-year Treasury yield stood at about 4.7% as of September 18th.

According to BofA, a flattening of the yield curve will emerge if the Fed continues to raise rates until financial conditions tighten. They projected that the two-year Treasury yield could rise to 5.25%, its 2023 peak, and noted that under the Taylor rule, the federal funds rate should stand at about 5.3%.

However, they expect increases in longer-dated Treasury yields to be limited, forecasting the 10-year yield will remain at its current level of 5% through the end of the year.