All eyes are on the Jackson Hole symposium, commencing today and concluding Saturday, and particularly on the signals Jerome Powell will send. In this context, Bank of America (BofA) examines how the Fed's monetary policy will affect European stocks. With the European Central Bank (ECB) maintaining a wait-and-see stance, likely to continue for the immediate months ahead, and markets having priced in almost a 25 basis point interest rate cut at the September Fed meeting, BofA poses a critical question: will lower interest rates in the US, and thus lower bond yields, act as a positive catalyst for the European market or signal the beginning of a major plunge?

Specifically, BofA estimates that US labor market weakness and increased political pressure on the Fed could unlock a new leg down in bond yields. Their economists argue that the recent slowdown in US employment growth increases the probability that the Fed may be forced into 'bad' rate cuts. Meanwhile, the American bank's interest rate strategists have become more positive on US bonds in response to weakening employment data, as well as the increasing prominence of 'low-rate advocates' among Fed policymakers. Is US employment weakness another false alarm? The US labor market experienced a mini-shock last summer but then accelerated again. This time, BofA economists argue that a recovery in wage growth is unlikely, given the negative impact from rising US tariffs, stricter immigration rules, and government spending cuts. They also expect further deceleration in US final demand growth after the weakness of the first half. Thus, despite signs of short-term consumer strengthening, they foresee a further pullback in growth momentum ahead.

Could lower interest rates be the catalyst for the next upside for European stocks? With estimated earnings per share (EPS) and estimated 12-month profit margins for European stocks already near historical highs, and the European equity risk premium (ERP) having approached an 18-year low, a decline in the real yield of US bonds—i.e., the risk-free discount rate for global stocks—is the last remaining potential upside catalyst after a strong rally that has seen the pan-European Stoxx 600 increase by 45% since 2022 and 100% from its Covid low in 2020, BofA notes.

Market Signals

The German DAX has entered a phase of strategic consolidation, trading within a narrow range of 24,300-24,600 points, reflecting investor caution ahead of Powell's address.
A dovish stance from Powell could trigger a rally in the DAX towards 25,000 points, driven by increased risk appetite and capital inflows into European assets. Conversely, a hawkish tone signaling persistent inflation concerns could lead to a 7%-15% sell-off in equities, mirroring past Jackson Hole events.
Sectors like utilities and real estate in Europe could benefit from a dovish Powell due to lower borrowing costs. Historically, Fed rate increases have negatively impacted Utilities, Materials, and Energy sectors, while Technology and Healthcare have shown more resilience.
Bank of America expects the Euro to strengthen against the US Dollar, Japanese Yen, and Swiss Franc due to perceived greater flexibility in the European Central Bank's stimulus measures compared to the Fed's "stag-flationary trade-offs."

Winners & Losers

Potential winners include companies in sectors that benefit from lower interest rates or a weaker dollar, such as utilities and real estate in Europe. U.S. multinationals could see earnings growth due to a depreciating dollar. Losers could be sectors highly sensitive to interest rate hikes or those facing persistent oversupply (e.g., US petrochemicals), or European financial sectors after their recent strong rally. European economies, particularly Germany (DAX), are highly sensitive to Fed policy signals.

Action Timeline

Immediate: Monitor Fed Chair Powell's speech at Jackson Hole closely for directional cues. A dovish pivot could present buying opportunities in European equities, particularly in interest-rate sensitive sectors.
Short-term: Identifying sectors likely to benefit from potential rate cuts (e.g., utilities, real estate) or those resilient to hawkish signals could offer first-mover advantages. Closely watch upcoming inflation data (July PCE, August CPI) and employment reports.
Long-term: BofA's macroeconomic assumptions suggest a plunge of approximately 10% for the Stoxx 600 to 490 points by early next year. European cyclicals vs. defensives are also expected to fall by ~10%, and 'Value' vs. 'Growth' stocks by ~10%. However, 'Quality' stocks with strong balance sheets and free cash flow are projected to see an upside of ~10%.

Risk Assessment

The primary risk is a hawkish tone from Powell, which could trigger a significant market sell-off, particularly impacting rate-sensitive stocks.
If inflation proves more persistent than anticipated, it could force the Fed to maintain higher rates for longer, dampening economic growth and weighing on equities.
The inherent uncertainty surrounding Powell's speech and the current economic climate creates a high potential for market volatility in the short term.
Warnings exist that if Fed decisions or economic data become politicized, there's an upside risk to inflation forecasts, potentially leading to lower real and nominal rates, a steeper yield curve, a weaker USD, and boosted commodities.

Key Indicators

US labor market weakness signals the potential for the Fed to be forced into rate cuts in response to weakening economic conditions, which may not be positive for equities.
The Fed's decisions will hinge on incoming economic data, particularly inflation reports like the July PCE (August 29) and August CPI (September 11).
BofA's forecast of a weakening global composite PMI from current 52 to 49 by Q1 next year indicates upward pressure on equity risk premiums and downward pressure on EPS expectations.

Regional Perspective

European equities are particularly sensitive to Fed policy decisions, with BofA noting the Stoxx 600 has risen 45% since 2022. The German DAX faces a period of strategic consolidation, with its future trajectory heavily dependent on Powell's tone. While the ECB remains on hold, any Fed moves will ripple through the European economic landscape. BofA's forecasts suggest a 10% plunge for the Stoxx 600, emphasizing the region's sensitivity to US monetary policy.

Immediate Implications

Investors should prepare for potential market volatility during the Jackson Hole symposium. Any hint of rate cuts driven by economic weakness could lead to a significant decline in European equities.
First-mover opportunities lie in re-evaluating portfolios based on Powell's different scenarios (dovish or hawkish) and adjusting exposure to interest-rate sensitive or resilient sectors.

What to Watch

Jerome Powell's Speech: The precise words used by the Fed Chair at Jackson Hole will set the tone for global markets.
US Inflation Data: July PCE (August 29) and August CPI (September 11) are crucial for confirming or refuting rate cut expectations.
US Labor Market: Continued weakness in employment data will bolster the case for 'bad cuts' by the Fed.
ECB Actions: Despite the wait-and-see stance, any changes in the ECB's position could add another layer of complexity for European markets.

Analysis

Bank of America's analysis provides a stark warning for European equity investors. While a Fed rate cut might seem like a positive catalyst, BofA emphasizes that the *reason* for the cut is paramount. If cuts are driven by macroeconomic weakness, particularly in the US labor market, this would lead to a surge in risk premiums and a decline in earnings expectations, potentially translating into a significant plunge for the European stock market. BofA remains negative on European equities, underweighting cyclicals versus defensives, and forecasts a substantial decline in key indices by early next year. This perspective underscores the need for careful risk assessment and strategic adjustments.