Bank of America strategist Michael Hartnett suggests the recent U.S. bond market sell-off may have concluded, with Treasury yields likely heading toward 4% rather than 6%. This outlook is anticipated to bolster long-duration equity sectors, including small caps, real estate investment trusts (REITs), and biotechnology, signaling a potential shift in investment flows and easing broader market concerns.

Market Overview

U.S. equities are poised for potential shifts in investment flows as a prominent strategist from Bank of America (BofA), Michael Hartnett, suggests a significant turning point in the U.S. bond market. Hartnett posits that the recent rout in U.S. Treasury bonds is likely over, with yields on course to stabilize around 4% rather than escalating towards 6%. This revised outlook, contingent on the absence of an inflation resurgence or a severe cooling of the labor market, is expected to provide a tailwind for interest-rate-sensitive equity sectors.

The Event in Detail

Global debt markets have recently experienced considerable volatility, with the U.S. 30-year Treasury yield briefly touching the 5% mark, a level not consistently observed in over two decades. This broad sell-off extended to international markets, with Japan's 30-year government bond yield reaching a record high of approximately 3.28% and the United Kingdom's 30-year gilt yields spiking to nearly 5.75%, their highest since 1998. Yields on French and German debt also hovered near multi-year peaks, reflecting mounting fiscal pressures across advanced economies. Hartnett noted that the next significant move in bond yields is likely to be downward, influenced by ongoing policy interventions, the Federal Reserve's (Fed) credibility regarding rate cuts, and weakening U.S. economic data, including declines in construction spending and home prices.

Contributing to this sentiment, swaps traders are now fully pricing in a Federal Reserve interest rate reduction at the September 2025 meeting. This expectation is largely driven by weaker-than-anticipated jobs data, particularly the August 2025 non-farm payrolls report, which showed the economy added a mere 22,000 positions, substantially missing Wall Street's expectation of around 75,000. This marked the fourth consecutive month of decelerating labor growth, with the unemployment rate climbing to a four-year high of 4.3%.

Analysis of Market Reaction

The anticipated decline in bond yields is projected to particularly benefit "unloved" long-duration equity sectors such as small caps, Real Estate Investment Trusts (REITs), and biotechnology. These sectors typically thrive in lower interest rate environments as borrowing costs decrease, improving future earnings estimates and making their valuations more attractive. The S&P 500, currently trading around $575.18, has demonstrated resilience despite recent market uncertainties, though its year-to-date return stands at -2.28% with a beta of 1.01, reflecting current market volatility. The expectation of accommodative monetary policy has already spurred a rotation out of high-growth technology stocks into sectors poised to benefit from lower borrowing costs, with small-cap and value stocks surging in August 2025.

Broader Context and Implications

Hartnett's analysis extends beyond U.S. borders, suggesting investors should consider selling UK and EU bonds, citing soaring yields in German and UK bonds reaching 15-year and 27-year highs, respectively. He also recommended selling Japanese bonds, noting that few had anticipated Japanese bond yields would exceed Chinese bond yields, with the 30-year Japanese government bond (JGB) yield at a 17-year high. Hartnett projects that the Nikkei will underperform until the Bank of Japan aggressively tightens its policy to regain credibility.

Domestically, Hartnett has indicated the beginning of a "U.S. government recession" following a five-year fiscal expansion, evidenced by weak payroll growth in government and quasi-government sectors and a higher savings rate among U.S. households. He warned that the U.S. is "one bad payroll number away from recession" and suggested that Treasury yields could fall below 4%, a scenario for which he believes few investors are prepared.

Despite these concerns, Bank of America data indicates a broad inflow across major asset classes in the week leading up to September 3. Cash led with $51.8 billion in inflows, followed by bonds at $22.2 billion, and stocks at $17.6 billion. Gold attracted $6.5 billion, marking its largest weekly inflow since April, while cryptocurrencies saw $500 million. Notable trends include $200 billion flowing into cash over five weeks and uninterrupted inflows into bonds since April, totaling $358 billion.

Expert Commentary

Michael Hartnett of Bank of America articulated a "Goldilocks" scenario for risk assets:

"Most bullish outcome for risk assets = strong >150k Aug payroll and Treasury yields fall (the full Goldilocks)." Conversely, he identified the "most bearish" case as negative payrolls combined with rising yields due to debt default concerns. This perspective underscores the delicate balance the market currently navigates between labor market strength and interest rate trajectories.

Looking Ahead

The market's focus remains keenly on the Federal Reserve and upcoming economic indicators. The high probability of a September 2025 rate cut is expected to usher in a period of dynamic shifts, with equities, particularly growth stocks, technology companies, and small-caps, poised for a potential "relief rally" as lower borrowing costs are anticipated to boost future earnings. The real estate sector, including homebuilders like PulteGroup (NYSE: PHM) and D.R. Horton (NYSE: DHI), also stands to gain significantly from reduced mortgage rates and increased buyer demand. Investors will closely monitor further labor market reports and any pronouncements from Federal Reserve leadership for signals regarding the pace and magnitude of future monetary policy adjustments, which will shape the economic landscape in the coming months.