RBC and Bank of America issue warnings: US stocks could be severely impacted as the 10-year Treasury yield surpasses 5% June could be a "window for escaping".

With the market's increasing concerns about inflationary pressures boosting expectations of the Federal Reserve tightening monetary policy, US bond yields surged in response. Under the impetus of artificial intelligence (AI) narratives, the US stock market, which has been showing strong momentum, is facing a crucial test, with warnings from Wall Street giants RBC Capital Markets and Bank of America. Lori Calvasina, head of US stock strategy at RBC Capital Markets, raised her target for US stocks, but also warned that if the 10-year US Treasury yield rises to 5%, the bullish stance on the US stock market will face challenges such a level of US Treasury yield typically depresses valuation levels. Calvasina raised her 12-month target for the S&P 500 index from 7750 points to 7900 points. This new target is based on earnings per share of $329, a 10-year US Treasury yield of 4.5%, US inflation rate of 3.3%, and the assumption that the Federal Reserve will keep interest rates unchanged. She also added that if the inflation rate rises to 3.8%, the 10-year US Treasury yield rises to 5%, and the Fed is forced to raise rates, then her target for the S&P 500 index will be lowered to 7400 points. Calvasina also mentioned that according to the bank's model of earnings per share of $329 for the S&P 500 index in early 2027, if corporate profits decline by 5% year-on-year, the index will fall to 6300 points. She pointed out that a 5% 10-year US Treasury yield "seems to make the market nervous," and "these calculations show that what truly supports US stock market valuations is the earnings story, as well as the pressures that interest rates and price-to-earnings ratios must bear, which are the headwinds the market must face." However, she also noted that as more companies turn to long-term debt financing and reduce floating rates and short-term loans, the sensitivity of US corporate profits to fluctuations in the 10-year US Treasury yield is decreasing. She also pointed out that corporate net debt levels are decreasing over time. Meanwhile, according to Michael Hartnett, Chief Investment Strategist at Bank of America, due to the influx of investors and rising inflation risks, US stocks may see a round of profit-taking in early June. Hartnett said, "The process of investors chasing stocks and tech stocks may be completed thoroughly in the coming weeks, so early June is a time for moderate profit-taking." Hartnett and his team pointed out that price pressures in the US are spreading widely from energy, transportation to rents, while at the same time, US stocks are hitting new highs. Additionally, a series of events in June, including the OPEC meeting, World Cup, G7 summit, and the first Federal Open Market Committee (FOMC) meeting under Chair Wash, could act as market catalysts, making June an ideal window for reducing positions. Hartnett and his team believe that unless the rapid decline in the Consumer Price Index (CPI) in the past six months slows down, the year-on-year CPI growth rate in the US is likely to exceed 5% before the mid-term elections in November, which is not favorable for the stock market. Hartnett said that when the year-on-year CPI growth rate exceeds 4%, "risk assets will begin to feel uneasy." Based on data from the past 100 years, once the year-on-year CPI growth rate exceeds this level, the S&P 500 index typically falls by an average of 4% over the following three months and an average of 7% over the next six months. US stock valuations and technical indicators are also flashing "red lights" Apart from the warnings from major banks, two market signals that are significant enough to go down in financial history have simultaneously turned red this week, indicating that US stocks are experiencing an extremely rare double extreme state of valuation and technology. In terms of valuation, the cyclically adjusted price-to-earnings ratio (CAPE Ratio) developed by Nobel laureate Robert Shiller has soared to 42.32, just under 5% below the peak of the dot-com bubble in 2000. The warning significance of a high CAPE ratio from a historical perspective is self-evident: historically, the CAPE ratio has typically fluctuated around a long-term average of about 17. The current reading of 42.32 means that the valuation of the US stock market has exceeded most periods before the global financial crisis, the rebound after the pandemic, and even the majority of the dot-com bubble frenzy in 1999. Historically, this indicator has only reached similar or even higher extreme levels in two periods: on the eve of the Great Depression in 1929 and on the eve of the bursting of the dot-com bubble in 2000. Every major crash has begun with a sharp rise in the Shiller price-earnings ratio. Also rising simultaneously with valuations is market concentration. Currently, the top ten components of the S&P 500 index account for over 40% of the total market value, nearly 50% higher than the level of about 27% during the dot-com bubble in 2000. Tech giants such as NVIDIA, Apple, and Microsoft, which have contributed the vast majority of the index's gains, demonstrate a structural feature of dependence on a few stocks. Ben Snider, the new chief US stock strategist at Goldman Sachs, pointed out in his outlook report at the beginning of the year that the combination of "high valuations, extreme concentration, and strong recent returns in the US stock market is structurally similar to some overheated market rallies in the 20th century. On the technical side, a rare technical warning signal, the Hindenburg Omen, has been triggered simultaneously on the New York Stock Exchange and the Nasdaq, sparking vigorous debate among traders about whether the prosperity of the US stock market is becoming increasingly fragile beneath the surface. Historically, the Hindenburg Omen has appeared multiple times before major market corrections, including the 1987 stock market crash, the bursting of the dot-com bubble, and the onset of the financial crisis in 2008. In February 2026, the signal was triggered three times within six days, and over the past six months, there have been eight clusters of signals. Analysts warned at the time that "signals clusters often indicate a market top forming." As May progressed, the internal structure of the market further deteriorated. According to the latest data, while the S&P 500 index has frequently hit new highs in recent times, the divergence between the number of new highs and new lows on the New York Stock Exchange has continued to widen, with funds highly concentrated in a few large-cap stocks and the overall market participation significantly declining. The Goldman Sachs team of chief US stock strategists warned in their latest report that the current rally in the US stock market is highly concentrated in a few giant tech stocks, while market breadth has fallen to levels not seen since the dot-com bubble, indicating that downside risks are continuing to accumulate. However, traders also caution that the signal itself may be prone to false alarms, as a single trigger does not guarantee an imminent market crash. Technical analysts typically look for further confirmation signals in the following days to assess the validity of the omen. Both signals are significant enough to warrant attention, but more importantly, they both point to the same underlying issue beneath the facade of the stock indices hitting new highs, the participation in the rally may be rapidly narrowing, with the celebrations of a few tech giants masking the weakness of the majority of stocks. Inflation panic drives up US bond yields! Valuations of US stocks may face suppression With the Houthis Strait, a key chokepoint for global energy transportation, remaining almost closed, peace talks between the US and Iran at a standstill, concerns about high oil prices exacerbating inflationary pressures, and thereby boosting expectations of a Federal Reserve rate hike. In this context, US bond yields have been on the rise alongside the US dollar. On Friday, the 10-year US Treasury yield rose to 4.530%, the highest level since May 2025; the 30-year US Treasury yield hovered above 5%; and the 2-year US Treasury yield, which is particularly sensitive to interest rates, crossed the 4% mark, reaching its highest level in several months. Additionally, the US dollar is expected to rise by 1.3% this week, marking its largest weekly gain in two months. The latest data released this week confirms the inflationary pressures facing the US economy. Data released on Tuesday showed that with ongoing conflicts in the Middle East driving up gasoline prices and a sharp increase in the cost of groceries, US inflation continued to accelerate, with the Consumer Price Index (CPI) rising 3.8% year-on-year in April, the fastest pace since 2023. Data released on Wednesday showed that the Producer Price Index (PPI) in the US soared by 1.4% month-on-month in April, the largest monthly increase since March 2022, far exceeding market expectations of 0.5%; and the year-on-year increase was 6.0%, the highest level since December 2022, significantly surpassing the market's forecast of 4.8%. The sharp change in oil prices and the inflation environment has forced the market to undergo a historic reversal in pricing the Federal Reserve's policy path. Just before the Middle East conflict broke out in February, overnight index swap markets showed that traders generally expected the Federal Reserve to cut interest rates by about 50 basis points for the full year of 2026. However, the energy shock triggered by the war has completely shifted the outlook on interest rates. Currently, the CME Group's "Fed Watch" tool shows that the market has largely ruled out the possibility of a rate cut by the Federal Reserve before the end of 2027. Instead, the market expects a 39% probability of a 25-basis-point rate hike by the end of this year and a 37% probability of a 25-basis-point rate hike by the end of October 2027. In fact, the shift in expectations for Federal Reserve policy has long been evident in the internal divisions within the Fed. Last month's Federal Open Market Committee (FOMC) meeting saw the highest level of dissent since 1992 with as many as three officials voting against a policy statement that leaned towards easing. Even Fed Governor Lael Brainard, who was previously the most dovish, has significantly softened her stance and lowered her rate cut expectations. The upcoming official appointment of the new Federal Reserve Chair Wash has also sparked widespread market attention, with the prevailing expectation that his tenure will face challenging policy choices. Federal Reserve officials have also been sending hawkish signals in recent days. For example, Kansas City Fed President Schmidt said on Thursday that inflation is the biggest risk facing the US economy. Minneapolis Fed President Kashkari said on Wednesday that the Middle East conflict exacerbated already high inflation, and the Federal Reserve must bring the inflation rate back to its 2% target. Boston Fed President Collins also warned that if inflation pressures do not ease, the Fed may need to raise rates again. Chicago Fed President Guolsby pointed out on Tuesday that inflation is moving in the wrong direction, and this wrong direction is not just related to oil or tariffs. These officials' emphasis on inflation all points to one view: that the Federal Reserve is paving the way for a potential rate hike. Several Wall Street banks have recently delayed their forecasts for a rate cut by the Federal Reserve. These banks believe that both employment and inflation data support the reasons for the Federal Reserve to keep rates unchanged at least until the end of this year. For example, Adiya Bav, head of US economic research at Bank of America, wrote in a report last week, "The data simply does not support a rate cut this year. Core inflation is too high and rising. The strong April employment report was the last straw, especially considering Fed officials' hawkish comments." Bav and her colleagues now expect the Federal Reserve to cut rates again until July 2027, a significant change from the previous forecast of a rate cut in September this year. The consensus at present indicates that the Federal Reserve has entered "defense mode." Rates will stay at 3.50%-3.75% or even higher until the path to lowering inflation back to 2% becomes clear. Statements after the April rate decision show that the Federal Reserve's internal divergence between "fighting inflation" and "sustaining growth" has reached the most severe level in years. With the end of the Powell era and the upcoming appointment of Wash, the June meeting will be a key window to observe the new chair's policy style, but given stubborn inflation and geopolitical risks, policy is likely to remain in a wait-and-see mode in the short term. If inflation pressures persist due to high oil prices, the Federal Reserve will be forced to dispel thoughts of loosening monetary policy, and high interest rates will undoubtedly suppress the upward momentum of US stocks. The "Wash era" of the Federal Reserve opens! With the "tapering + new framework for inflation" on the horizon, the US stock market faces a stress test for the bull market In addition to the possibility of US stock valuations being suppressed due to rising US bond yields as a result of inflation concerns, the changes that new Federal Reserve Chair Wash is trying to bring to the central bank may also have a negative impact on US stocks. Wash's core reform directions include deleveraging the Federal Reserve's balance sheet, redefining or reshaping the Fed's framework for analyzing inflation, and bringing about technical and cultural changes within the central bank related to monetary policy. For the financial markets, the combined effect of these two reform initiatives led by Wash deleveraging the Federal Reserve's balance sheet and redefining or reshaping the Fed's framework for analyzing inflation is likely to increase the pressure on the discount rate of highly valued assets. As inflation remains high, energy shocks have not subsided, and employment remains resilient. The new chair is unlikely to swiftly pivot towards easing rates. But if he simultaneously advances tapering, weakens excessive forward guidance, strengthens the priority of price stability, the market will gradually shift from "trading on Powell-era rate cut expectations" to "trading on Wash-era term premium and inflation credibility." This implies that the rates of longer-term bonds, such as 10 years and above, will be less likely to decline rapidly, which in turn will limit the expansion space for overvalued assets for risk assets like global stock markets. From a financial market perspective, what matters is not whether Wash personally "wants to cut rates", but whether the bond market believes he can enhance the Fed's credibility against inflation. If Wash prematurely sends dovish signals in a high inflation environment, long-term US bond yields, through unanchoring inflation expectations and rising term premiums, will "punish" a policy pivot, pushing the 10-year yield closer to or even test 5%. The higher oil prices go, the harder it is for inflation to recede, and investors will demand higher compensation. And an uptick in 10-year yields will raise discount rates for mortgages, corporate debt, leverage loans, and stock valuations, directly suppressing the upward momentum of overvalued US stocks and the narrative of AI capital expenditures.