Bank of America Global Research strategists said Tuesday that the biggest risk to U.S. stocks is not rising bond yields, but a sharp widening of corporate credit spreads. The warning came as global bond yields climbed to multi-year highs, rattling equity investors who fear a correction.
The strategists, led by Michael Hartnett, wrote that credit markets typically crack before stocks do. When high-yield spreads blow out, borrowing costs surge for companies and recession fears replace inflation worries. That sequence has preceded every major equity bear market since the 1990s.
"The bond yield spike is a symptom, not the disease," the BofA team wrote in a note to clients. "Credit is the canary in the coal mine. Until spreads widen materially, the equity selloff is likely contained."
So far, credit markets have held up. The ICE BofA U.S. High Yield Index option-adjusted spread sits near 350 basis points, well below the 500-plus levels that historically signal distress. Investment-grade spreads remain tight as well.
Equities have wobbled nonetheless. The S&P 500 has slipped from its July peak as the 10-year Treasury yield pushed above 4.5%, its highest since 2007. The Nasdaq has fared worse, with rate-sensitive tech names bearing the brunt of the selling.
Investors have dumped stocks on the logic that higher yields make bonds more attractive and compress equity valuations. But BofA argues that math only goes so far. What matters more, the firm says, is whether companies can still refinance their debt at reasonable rates.
That question looms large. U.S. corporations face roughly $1.3 trillion in debt maturing through 2025, according to S&P Global Ratings. If credit spreads stay tight, most of that debt can be rolled over without drama. If they don't, defaults rise and earnings collapse.
Fed policy sits at the center of the puzzle. The Federal Reserve has held rates at a 22-year high and signaled it may keep them there longer than markets expect. Higher-for-longer rates pressure both bond prices and corporate borrowers.
BofA's advice to clients: watch the spread between corporate bonds and Treasurys, not the yield on the 10-year note. A move above 500 basis points in high-yield spreads would be the signal to cut equity exposure, the firm said.
Other Wall Street banks have echoed similar caution. Morgan Stanley has flagged credit conditions as a key indicator for months, while Goldman Sachs recently noted that default rates remain low but are ticking up among lower-rated issuers.
For now, the credit market is sending a calm message. Whether that holds depends on earnings, Fed policy, and whether borrowers can keep servicing their debts in a world where money is no longer free.
