Rising interest rates could re-emerge as a threat to stocks, Bank of America says

• Stocks plunged last year as the Fed started raising interest rates, but they've bounced back in 2023.
• And yet, it might be time for investors to start worrying again, according to Bank of America.

High interest rates could be about to re-emerge as a threat to the stock market even as investors eye the loosening of monetary policy as early as the first quarter of next year, according to Bank of America

Stocks have rallied hard this year, with investors seemingly having shrugged off the Federal Reserve's most aggressive tightening campaign since the 1980s.

After a dismal 2022 where stock prices cratered as the central bank started to lift borrowing costs, the S&P 500 has jumped nearly 18% year-to-date, powered higher by the rise of AI, cooling inflation, and dwindling recession odds.

However, in a note to clients on Tuesday, Bank of America analysts warn: "US rates climbing close to last year's highs may pose an underpriced risk for the equity market."

"Higher yields were a major driver of S&P downside in 2022, but the market's sensitivity to rates seemed to weaken this year. At least until recently," they added, noting that the correlation between the benchmark index and 10-year US Treasury yields recently fell to its lowest level in 23 years.

The Fed has tightened by 525 basis points over the past 17 months in a bid to clamp down on inflation. Bond yields are typically closely tied to the bank's benchmark rate – and when they rise, fixed-income assets grow more appealing relative to stocks, as they offer increasingly large returns with much less risk.

Bank of America's warning comes as waves of positive economic data have given investors plenty to be hopeful about. The bank's own forecasters walked back a previous prediction that there would be a US recession in 2023 last week, citing solid growth and near-record low unemployment.

But recession fears ebbing could just end up putting rising rates back to the top of investors' list of worries, BofA said.

"Should concerns about recession keep fading and fears of inflation or a tighter-than-expected Fed return, there is a risk that higher rates once again become a headwind for stocks," the analysts wrote.