Bank of America’s latest edition of The Flow Show shifts the market conversation away from earnings and back toward bonds. In the report, BofA says the 30-year U.S. Treasury yield has climbed to 5.2%, its highest level since June 2007, while the 30-year real yield has reached 3%, the highest since November 2008. For risk assets, the bank argues, long-end rates are starting to displace corporate earnings as the more important pricing variable.
BofA sums up the current backdrop with a short formula: FCI > EPS. In other words, changes in financial conditions are becoming more important than marginal changes in earnings.
That does not mean earnings have rolled over. The bank’s global earnings model still projects roughly 9% growth in global earnings per share over the next 12 months. The question, instead, is whether current valuations, positioning and funding costs can keep coexisting at the levels markets have become used to.
BofA lays out a clear chain of logic. Rising long-end yields tighten financial conditions. Tighter financial conditions reinforce expectations for Federal Reserve hikes or a hawkish policy stance. If bank stocks stop benefiting from higher rates and begin falling as yields rise, investors may start cutting leverage and risk exposure, forcing a repricing of crowded trades in technology, financials and industrials.
Bonds are challenging the market’s usual playbook
Over the past few years, equity investors have repeatedly tried to absorb higher rates through stronger earnings growth. The logic has been straightforward: as long as the economy stays firm, technology companies keep delivering growth, and higher rates do not meaningfully damage credit or consumption, equities can still find a balance between higher valuations and higher risk-free rates.
BofA says the bond market is now challenging that framework. Before the report was published, markets had pushed the probability of a July 29 Fed rate hike to about 38% and had largely priced in the possibility of another hike by September 16. That stood in contrast with BofA’s July global fund manager survey, in which 83% of respondents had expected the Fed not to raise rates before the U.S. midterm elections.
According to the report, this gap shows a growing split between what equity investors and bond investors expect from the policy path ahead. Stocks are still trading earnings growth, AI investment and economic resilience. Bonds are starting to focus on the risk that if inflation stays in the 3% to 4% range, the labor market remains largely untouched by AI, and fiscal deficits and Treasury supply keep expanding, the Fed may need to tighten policy again.
That is what the title “Bonds Bringing the Heat” is meant to capture: bond yields are heating up and pushing higher funding costs into equities, credit and the real economy.
How higher long-end yields feed through markets
BofA says rising long-end yields affect the market through several channels at once.
- First, they directly raise corporate funding costs. Whether companies are issuing debt, pursuing mergers and acquisitions, or expanding capital spending, higher rates increase the hurdle for capital.
- Second, they lift the discount rates used in equity valuation. That matters especially for technology companies whose profits are weighted further into the future. Even if earnings forecasts hold up, higher real yields can compress the multiples investors are willing to pay.
- Third, they increase government interest expense, which raises dependence on bond issuance and, in turn, adds more pressure to the long end of the curve.
The bank argues that the pressure is not only about near-term Fed moves. It also reflects deeper supply-side shifts in the 2020s. Compared with the 2010s, when globalization, demand-led growth and low inflation dominated, the current decade is moving toward a more supply-driven setup. Labor supply is constrained by immigration policy, goods supply is affected by tariffs and protectionism, energy supply remains vulnerable to geopolitical conflict, while government bond supply continues to expand.
BofA notes that the U.S. government is still running an annual fiscal deficit close to $2 trillion, with annual interest expense around $1 trillion. Even if tariff revenues rise, the report says, that is unlikely to fundamentally change the fiscal structure. In this reading, long-end rates are facing not only monetary policy risk but also structural pressure from deficits, debt issuance and supply-side inflation.
At the same time, the bank does not say yields will rise without limit, nor does it declare that U.S. equities must enter a bear market. Its point is narrower. Markets have grown used to reading high rates as a sign of strong growth, but once rates reach a higher level, they can also begin to restrain growth and risk appetite. High rates can be the result of a strong economy, but they can also become a source of pressure on that same economy.
Why bank stocks matter more than the headline yield level
BofA places bank stocks at the center of its framework. Rising yields by themselves do not automatically mean risk assets have to weaken. In a typical reflation or growth trade, higher long-end rates usually signal better growth expectations and a steeper yield curve. In that environment, banks can earn more from higher asset yields, and bank shares often rise alongside bond yields.
That is the market relationship BofA describes as normal: yields rise, growth expectations improve, bank earnings benefit, and bank stocks move higher.
The more important shift would be a reversal in that relationship. If markets move from “higher yields, stronger bank stocks” to “higher yields, weaker bank stocks,” the meaning of rates changes. Investors would no longer be reading higher rates mainly as a sign of economic strength. They would start focusing on higher deposit costs, funding pressure, unrealized losses on securities portfolios, commercial real estate risk and changes in credit quality.
At that point, bank stocks would be moving from beneficiaries of higher rates to carriers of tighter financial conditions. BofA treats that change as a key confirmation signal for de-risking in broader risk assets because banks are not just another equity sector. They sit at the intersection of credit creation, balance-sheet expansion and market liquidity.
The report stops short of saying this signal has already arrived. Before it does, markets may still absorb rate pressure through earnings growth, sector rotation and changing policy expectations. That is why BofA frames banks not as a tool for calling an exact top, but as a way to tell whether high rates are still expressing economic resilience or have started to damage the financial system.
Industrial semiconductors are flashing an earlier warning
The report also highlights industrial semiconductors as a leading signal. A “blue-collar semiconductor” index made up of Texas Instruments, Analog Devices, NXP, Microchip, ON Semiconductor, STMicroelectronics, Infineon and Monolithic Power has fallen about 21% from its June high.
Unlike AI chip companies such as NVIDIA, those firms are more exposed to autos, industrial equipment, energy, communications and manufacturing. BofA says they are often treated as early indicators for the industrial cycle and real-economy demand. Their move into technical bear-market territory suggests that, at least across the industrial chain, markets are already showing signs of divergence.
Even so, money has continued to crowd into favored areas. Over the four weeks in July, technology funds took in a record $52.8 billion, while financial funds attracted $8.8 billion, the biggest inflow since January 2022. Industrials also rank among the most overweight sectors for investors since 2021.
Those flows show confidence has not disappeared. But they also point to rising crowding risk. When positioning, narrative and valuation all concentrate in a small group of sectors, even modest changes in rates, policy expectations or fund flows can produce larger price swings, whether or not fundamentals have materially worsened.
BofA’s bull-and-bear indicator is at 9.6, well above its 8.0 contrarian sell threshold, while global fund manager cash levels have dropped to 3.6%, below the 4.0% sell threshold. The bank does not present that as proof of an imminent decline. It does argue that in a market with high positioning and low cash, the room to absorb surprises gets smaller.
In that sense, the report reads these signals as a temperature check. When positioning, flows and sentiment are all elevated, the market may be moving out of a one-way rally phase and into a period where earnings quality, valuation discipline and portfolio structure matter more.
Not an all-out bearish call, but a case for rebalancing
BofA does not recommend abandoning equities altogether. The report’s main message is a style shift: away from high-beta, cyclical and valuation-expansion trades tied closely to a strong-growth narrative, and toward defensives, dividend exposure, the U.S. dollar and duration assets that could benefit if growth cools.
In its tactical framework, the bank recommends being long defensives, dividends, the dollar and duration, while reducing exposure to crowded positions in banks, brokers, technology and industrials. The emphasis is not on making a simple binary call over which assets will rise and which will fall. It is about reducing dependence on one macro scenario.
If strong growth, earnings expansion and rising risk appetite continue, technology, financials and industrials could still perform on fundamentals. But if long-end yields keep moving up and financial conditions keep tightening, the swings could be larger in assets with rich valuations, heavy positioning and high cyclical sensitivity.
That makes the recommendation a rebalancing exercise rather than an outright reversal. BofA is arguing for keeping exposure to growth assets while adding positions that can offset changes in rates, policy expectations and the economic outlook.
BofA’s duration call comes in two stages
The bank also says “long duration” should not be misread as a blanket call to buy long-dated Treasurys immediately while long-end yields are still rising and supply pressure remains in place.
Instead, it describes a two-stage setup. In the first stage, inflation, fiscal supply and rate-hike expectations keep pushing long-end yields higher, leaving long bonds under pressure. In the second stage, if rates eventually become high enough to hurt the economy, banks and risk appetite, growth expectations cool and the Fed shifts toward stabilizing long-end yields, duration assets could gain more rebound potential.
Put differently, BofA is not saying bonds have already bottomed. It is saying that the longer high rates persist, the greater the chance they create the conditions for slower growth and a policy turn.
The U.S. dollar, meanwhile, is presented as a more direct hedge in that framework. If the Fed stays more hawkish than markets expect, both rate differentials and demand for safety could continue to support the dollar.
Flows into Asia and emerging markets are strong, but crowding risk is there too
The report also points to signs of global rebalancing from the U.S. toward Asia and emerging markets. In the week the report was published, emerging-market equity funds saw $29.6 billion in inflows, close to the second-highest level on record. China equities drew $21.3 billion, the third-highest on record, and South Korea saw cumulative inflows of $16.3 billion over the past four weeks, a record high.
BofA adds a caution here as well. A structural positive view is not the same as chasing short-term momentum. If China, South Korea, technology and emerging markets all receive extreme inflows at the same time, short-term trades can become crowded very quickly. The longer-term rerating case for Asian assets may remain intact, but after large inflows, prices become more sensitive to shifts in the dollar, rates and policy expectations.
What the bond market is forcing investors to watch
The report does not say a U.S. equity bear market is imminent. Earnings are still growing, AI investment is still expanding, and global capital has not pulled out of risk assets across the board.
What it does say is that long-end yields are now acting like a temperature gauge for the market. They are signaling that financial conditions are getting hotter, and the next question is whether that pressure will spread into banks, credit and corporate earnings. Even if financial conditions continue to tighten, BofA does not argue that the only outcome is a broad selloff. A more likely path, in its view, is a rotation away from areas with stretched valuations and heavy positioning toward assets with steadier earnings, more stable cash flows and more reasonable pricing.
For that reason, the bank’s key test is not simply whether yields keep rising. It is whether bank stocks can keep benefiting from that rise. If that link breaks, the repricing pressure on crowded trades in technology, financials and industrials could become much harder for markets to ignore.