BofA Report: Rising Long-Term U.S. Bond Yields May Redefine Risk Asset Pricing

The U.S. stock market has not turned bearish, but it’s important to closely monitor whether bank stocks can continue to withstand high interest rates and how crowded tech and financial trades will be repriced.

Original report: BofA Global Research, "The Flow Show: Bonds Bringing the Heat," July 23, 2026

Authors: Michael Hartnett, Anya Shelekhin, Myung-Jee Jung, Jessica Guo

Compiled and organized by DaiDai, Frank, MSX MaiTong

• The U.S. 30-year Treasury yield has risen to 5.2%, with the real yield reaching 3%; long-term interest rates are now replacing corporate earnings as the key driver of risk assets.
• Over the past four weeks, technology and financial funds saw inflows of $52.8 billion and $8.8 billion, respectively; capital continues to enter, but trading congestion has risen significantly.
• The most critical confirmation signal is not whether yields continue to rise, but whether bank stocks can continue to benefit from high interest rates;
• If yields rise but bank stocks decline, it suggests that higher interest rates may be shifting from a signal of economic strength to a source of pressure on financial conditions;
• BofA is not broadly bearish on equities but rather suggests a potential shift in the market from high-beta, cyclical, and crowded trades toward defensive sectors, dividends, the U.S. dollar, and duration assets that may benefit from a cooling economy;

Recently, the stock and bond markets have begun to offer two somewhat different answers.

The stock market continues to discuss corporate earnings, AI investments, and economic resilience, while the bond market worries whether current asset prices can withstand higher funding costs if inflation fails to decline and fiscal deficits remain unchecked, forcing the Fed to re-raise interest rates.

This is precisely the question the latest episode of Bank of America’s The Flow Show seeks to answer.

As of the report's release, the U.S. 30-year Treasury yield rose to 5.2%, reaching its highest level since June 2007; the 30-year real yield climbed to 3%, the highest since November 2008; meanwhile, continued declines in long-term bond prices pushed U.S. tech company bond prices to their lowest level in two years.

The current environment is summarized as: FCI > EPS.

In other words, changes in financial conditions are becoming more important than marginal changes in corporate earnings.

This does not mean that U.S. corporate earnings have deteriorated; on the contrary, BofA’s global earnings model still forecasts global EPS growth of approximately 9% over the next 12 months. The real question, therefore, is whether current valuations, positioning, and financing costs can sustain the previous equilibrium, even as earnings continue to grow.

This also forms the most important logical chain of the entire report:

Rising long-term yields have tightened financial conditions; tighter financial conditions, in turn, have reinforced expectations of further Fed rate hikes or a continued hawkish stance. If bank stocks can no longer benefit from high rates and instead decline as yields rise, the market may begin to reduce leverage and risk exposure, ultimately leading to a repricing of crowded trades in sectors such as technology, finance, and industrials.

Over the past few years, whenever U.S. equities faced rising interest rates, the market has attempted to absorb the pressure through earnings growth.

The logic is also straightforward: as long as the economy remains strong, tech companies continue to deliver growth, and high interest rates do not significantly dampen credit and consumption, investors are willing to believe that U.S. equities can continue to find a balance between higher valuations and higher risk-free rates.

But this time, the bond market is challenging this logic.

Before the report was released, the market had already pushed the probability of a Fed rate hike on July 29 to approximately 38% and largely priced in the possibility of another hike before September 16, whereas in the July global fund manager survey, 83% of respondents originally believed the Fed would not raise rates before the U.S. midterm elections.

This means that stock and bond investors are showing a clear divergence in their assessments of future policy directions.

The stock market is still trading on expectations of earnings growth, AI investments, and economic prosperity; meanwhile, the bond market is beginning to worry that, with inflation remaining at 3%–4%, the labor market yet to be significantly impacted by AI, and fiscal deficits and government debt supply continuing to expand, the Federal Reserve may be forced to re-tighten policy.

This is the true meaning behind the report title “Bonds Bringing the Heat”—bond yields are heating up and transmitting higher funding costs to equities, credit, and the real economy.

The reason is not hard to understand: rising long-term yields affect the market through multiple channels:

• First, it directly increases companies' cost of capital. Whether issuing bonds, pursuing mergers and acquisitions, or expanding capital expenditures, higher interest rates raise the threshold for accessing funds.
• Second, it raises the discount rate used to value stocks. For technology companies whose profits are concentrated in the future, even if earnings forecasts are not revised downward, higher real interest rates reduce the valuation multiples investors are willing to pay;
• Finally, it will also increase government interest expenses, heighten fiscal reliance on bond supply, and in turn exert downward pressure on long-term yields;

BofA believes that this pressure does not stem entirely from short-term policy changes, but is related to deeper supply-side structures of the 2020s.

Compared to the 2010s, which were dominated by globalization, demand-driven growth, and low inflation, the 2020s are gradually shifting toward a more supply-driven market: labor supply is constrained by immigration policies, goods supply is affected by tariffs and protectionism, energy supply is vulnerable to geopolitical disruptions, while government bond supply continues to expand.

The U.S. government continues to run an annual budget deficit of nearly $2 trillion, with annual interest payments totaling approximately $1 trillion. Even with increased tariff revenues, it is difficult to fundamentally alter the fiscal structure.

Therefore, long-term interest rates face not only changes in Federal Reserve policy but also structural pressures from fiscal deficits, bond issuance supply, and supply-side inflation.

However, this does not mean long-term interest rates will rise indefinitely, nor does it mean U.S. stocks are inevitably headed into a bear market. A more accurate understanding is that markets have historically interpreted high interest rates as a sign of "sufficient economic strength," but as rates rise further, they gradually begin to constrain economic growth and risk appetite.

High interest rates can be both a result of a strong economy and a source of pressure on it.

The boundary between the two states is most likely to first appear in bank stocks.

An increase in yields does not necessarily mean that risk assets will necessarily weaken.

In a typical reflation or economic expansion trade, rising long-term interest rates usually indicate improved growth expectations and a steeper yield curve. In such scenarios, banks can earn higher interest income as asset yields rise, causing bank stocks to often move in tandem with bond yields.

In other words, the market is currently trading on the scenario where "rising yields → improved economic outlook → increased bank profitability → rising bank stocks."

What truly matters is whether the relationship between bank stocks and bond yields is beginning to reverse, such that it becomes “yield continues to rise → financing and liability costs increase → credit and balance sheet pressure rises → bank stocks decline.”

Once the market shifts from "rising yields, rising bank stocks" to "higher yields, weaker bank stocks," the meaning changes significantly.

At this point, investors no longer view high interest rates solely as a sign of economic strength; instead, they are beginning to worry about higher deposit costs, funding pressures, unrealized losses on securities assets, commercial real estate risks, and changes in credit quality.

Bank stocks, once beneficiaries of high interest rates, will gradually become bearers of pressure from tighter financial conditions; BofA views this shift as a key confirmation signal for deleveraging in risk assets.

Because the banking sector is not just an ordinary stock category—it is also linked to credit creation, balance sheet expansion, and market liquidity—when bank stocks can no longer benefit from rising yields, it often signals that high interest rates have approached or surpassed the critical point where growth indicators turn into financial stress.

However, before this signal truly emerges, the market may still absorb interest rate pressures through earnings growth, sector rotation, and policy expectations. Therefore, the significance of bank stocks lies not in prematurely signaling a market top, but in helping investors determine whether current high interest rates still reflect economic resilience or have begun to harm the financial system.

Another noteworthy leading indicator comes from industrial semiconductors.

The "blue-collar semiconductor" index, comprising companies such as Texas Instruments, Analog Devices, NXP, Microchip, ON Semiconductor, STMicroelectronics, Infineon, and Monolithic Power, has declined approximately 21% from its June high.

Unlike AI chip companies such as NVIDIA, these firms' products are more widely used in automotive, industrial equipment, energy, communications, and manufacturing, making them often regarded as leading indicators of industrial cycles and real economy demand. The fact that blue-collar semiconductors have entered a technical bear market first suggests that, at least along the industrial chain, the market has begun to show marginal divergence.

Notably, over the four weeks of July, technology funds saw a record-breaking inflow of $52.8 billion; financial funds experienced their largest inflow since January 2022, at $8.8 billion; and the industrial sector reached one of the most significant overweight levels by investors since 2021.

Continuous capital inflows indicate that the market still has confidence in these directions. However, the higher the concentration of capital, the more sensitive the market becomes to changes in expectations. When positioning, narratives, and valuations all converge on a narrow set of sectors, even minor shifts in interest rates, policies, or capital flows—without any clear deterioration in fundamentals—can lead to greater price volatility.

The BofA Bull & Bear Indicator is currently holding at 9.6, well above the contrarian sell threshold of 8.0; the global fund managers' cash allocation has also fallen to 3.6%, below the 4.0% sell threshold.

This means the market is not lacking in optimistic consensus—in fact, optimism has become the dominant view. What needs to be noted is that when investors are highly positioned and holding less cash, the market’s short-term capacity to absorb unexpected shocks diminishes.

Overall, this is better understood as a market thermometer: when positions, capital flows, and sentiment are all at high levels, the market may transition from a one-sided rally phase into a phase that demands higher standards for profit quality, valuation levels, and capital structure.

It should be emphasized that Bank of America did not simply conclude to "sell all stocks and go completely bearish."

The report truly reflects a shift in market style—from assets characterized by high beta, strong cyclicality, reliance on valuation expansion, and expectations of economic prosperity—toward defensive, dividend-paying, dollar-denominated assets, and those that may benefit from a cooling of growth.

Within its tactical framework, BofA recommends going long on defensive sectors, dividends, the U.S. dollar, and duration, while reducing exposure to crowded positions such as banks, brokerages, technology, and industrials.

The focus here is not simply to determine which assets will rise or fall, but to manage the portfolio’s dependence on any single macroeconomic scenario.

If the market continues to experience strong growth, profit expansion, and rising risk appetite, technology, financials, and industrials may still perform well based on fundamentals; however, if long-term interest rates rise further and financial conditions continue to tighten, assets with high valuations, high positioning, and high cyclical sensitivity could experience more pronounced volatility.

Therefore, BofA’s recommendation is essentially a rebalancing aimed at increasing assets that hedge against changes in interest rates, policy, and economic expectations, while maintaining exposure to growth assets.

The most commonly misunderstood phrase is "how long to hold," which does not mean blindly buying long-term U.S. Treasuries while long-term yields are still rising and bond supply pressures have not eased.

More precisely, this is a trading logic that may be divided into two phases:

• In the first phase, inflation, fiscal supply, and expectations of rate hikes pushed long-term yields higher, continuing to pressure long-bond prices;
• In the second phase, if excessively high interest rates ultimately dampen the economy, banks, and risk appetite, and expectations of prosperity begin to cool, the Fed will shift toward stabilizing long-term rates, allowing duration assets to gain greater rebound resilience.

In other words, BofA is not betting that bonds have already hit their bottom, but rather that the longer high interest rates persist, the higher the probability becomes of growth slowing and a policy shift.

The U.S. dollar serves as a more direct hedging tool within this framework; if the Federal Reserve’s stance is more hawkish than market expectations, both yield differentials and safe-haven demand could continue to support the dollar.

Meanwhile, global capital is showing signs of rebalancing from the United States toward Asia and emerging markets; during the week the report was released, emerging market equity funds saw inflows of $29.6 billion, nearing the second-highest on record; China equity funds attracted $21.3 billion in inflows, the third-highest on record; and South Korea recorded cumulative inflows of $16.3 billion over the past four weeks, setting a new record.

However, structural optimism is not the same as short-term momentum chasing. When extreme capital inflows occur simultaneously in China, Korea, technology, and emerging markets, short-term trading can also become crowded. The long-term revaluation thesis for Asian assets can still hold, but after a surge of concentrated capital inflows, prices become more vulnerable to shifts in the dollar, interest rates, and policy expectations.

This report does not declare that the U.S. stock market is about to enter a bear market.

Corporate profits continue to grow, AI investments are still expanding, and global capital has not fully withdrawn from risk assets.

Long-term interest rates themselves act like a thermometer, reminding the market that financial conditions are warming, and it is crucial to closely monitor whether this pressure will further spread to banks, credit, and corporate profitability.

Even if financial conditions continue to tighten, the market does not necessarily have to experience a broad decline; more likely, capital will gradually shift from overvalued and overleveraged sectors toward assets with more certain earnings, more stable cash flows, and more reasonable valuations.

We need to identify where the heat is moving and readjust the risk-to-opportunity ratio before the market completes its next pricing cycle.