BofA’s Hartnett Warns Dovish Fed Rate Cut Imperils Stock Rally

(Bloomberg) — The year-end rally in equities is at risk from a Federal Reserve outlook that’s too cautious on the economy, according to Bank of America Corp. (BAC) strategists.

With the S&P 500 Index (^GSPC) within striking distance of a record high, investors are confident about a best-case scenario where the Fed cuts interest rates alongside falling inflation and economic growth remains resilient.

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But that optimism stands to be tested if the central bank sends dovish signals at the meeting next week, according to BofA strategist Michael Hartnett, as they could suggest a bigger-than-expected economic slowdown.

“Only thing that can stop Santa Claus rally is dovish Fed cut causing a selloff in long-end,” Hartnett wrote in a note, referring to Treasuries with a longer maturity date.

US stocks have rallied as investors bet the central bank would reduce rates further to shore up a softening labor market. Wagers on a quarter-point cut at the meeting on Dec. 10 have soared to over 90% from 60% just a month prior, according to swaps markets. Traders have also fully priced in three cuts by September 2026.

The S&P 500 is now about 0.5% away from its October peak, and seasonal trends generally bode well for a year-end rally. However, this time the market faces two risk events in the form of key jobs and inflation reports due later in December after being delayed by the government shutdown.

Hartnett and his team also note that the US administration is likely to intervene to stop inflation from running hot and the unemployment rate rising to 5%. They recommend positioning for that possibility by buying “inexpensive” mid-caps into 2026. They also see the best relative upside in sectors linked to the economic cycle, such as homebuilders, retailers, REITs and transportation stocks.