Before the election, the U.S. chooses the "escape velocity strategy"? Bank of America claims the Federal Reserve will save the housing market and suggests trading "large leverage."

Bank of America analysts believe that a significant interest rate cut, referencing the experience of the Volcker era, could trigger "massive re-leveraging," releasing frozen cash and revitalizing the real estate market.

According to the Wind Trading Desk, Bank of America's latest Research Investment Committee (RIC) report indicates that on the eve of the midterm elections, the U.S. may adopt an "escape velocity strategy" to stimulate economic growth, with the Federal Reserve potentially implementing more aggressive rate cuts to unfreeze the real estate market.

Currently, U.S. stocks are at historical highs, but two major asset classes are stagnant: American households hold the highest cash ratio since 1991, and existing home sales have dropped to levels seen during the financial crisis, with interest rates being a common factor.

Bank of America believes that if policymakers adopt more aggressive rate cuts (with the federal funds rate dropping to 1-2% and the 10-year Treasury yield falling to 3.25%), it would benefit small-cap value stocks, home builders, long-term Treasuries, emerging market bonds, and gold. Bank of America's baseline scenario expects the 10-year Treasury yield to be 4% by the end of the year and the federal funds rate to be 3.9%, but the "escape velocity" strategy could lead to an unexpected market performance.

The Volcker Precedent: How Rapid Rate Cuts Unfreeze Markets

Bank of America analysts point out that the current market faces a "frozen" state in two major asset classes: household cash holdings and the real estate market. Data shows that American households currently hold $19.6 trillion in cash and equivalents, with the ratio to liabilities reaching the highest level since 1991. Meanwhile, existing home sales are projected to average 4 million units in 2025, similar to levels seen after the 2008 global financial crisis.

Historical experience indicates that the significant rate cuts implemented by Volcker in the mid-1980s after successfully controlling inflation provide a precedent for addressing similar issues. At that time, the federal funds rate dropped from 20% to 8.5%, and as households re-leveraged, the S&P 500 index rose at an annualized rate of 31%, doubling in value at the market peak.

Currently, the gap between mortgage rates and effective rates has reached the largest level since the Volcker era, providing policymakers with room for significant rate cuts.

Policymakers May Push for an "Escape Velocity" Strategy

Bank of America economist Aditya Bhave states that considering the upcoming midterm elections, the government may wish to maximize economic growth. The two most important policy tools may be lowering interest rates and stimulus checks funded by tariff revenues. Treasury Secretary Yellen recently hinted that the Trump administration is considering declaring a "housing emergency" in the fall, which holds significant importance in the context of the midterm elections.

Mortgage expert Chris Flanagan points out that to "unfreeze" the real estate market, the 30-year mortgage rate needs to drop to around 5%, a decrease of 125 basis points from the current level of 6.25%. This would require the 10-year Treasury yield to fall to around 3.25% and the federal funds rate to be in the 1%-2% range.

Interest rate strategist Ralph Axel's research shows that the Federal Reserve has more control over the 10-year Treasury yield than the market perceives, with overnight rates and expected overnight rates two years out jointly determining 95% of the 10-year Treasury yield's movement. If the Federal Reserve significantly cuts rates to 1%, the expected 10-year yield would fall below 3%, and the 30-year mortgage rate would be below 5.5%

Five Major "Re-Leverage" Trading Opportunities

1. Small-Cap Value Stocks (SVAL, AVUV): Over 45% of small-cap debt consists of short-term and floating-rate instruments, benefiting significantly from a rate-cutting environment. Small-cap stocks are at historically low valuations relative to large-cap stocks, with a forward price-to-earnings ratio of 0.73 times, below the historical average of 0.99 times.

2. Homebuilders (ITB, XHB): In the past six rate-cutting cycles, homebuilders outperformed the S&P 500 by 19 percentage points. Despite a 150-point rise since the 2022 low, investors have net redeemed $1.9 billion over the past decade, indicating further upside potential.

3. Long-Term Treasuries (TLT, SPTL): Faster rate cuts will boost long-duration government bonds. Michael Hartnett points out that there is almost no duration exposure in global allocator portfolios, providing trading opportunities for Treasuries.

4. Emerging Market Bonds (XEMD, EMBD): Historically, emerging market bonds have benefited from lower interest rates and a weaker dollar, with emerging market central banks cutting rates even more than the Federal Reserve. Over the past 30 years, emerging market bonds have delivered an annualized return of 6.4%, surpassing the 3.7% of emerging market stocks and 3.6% of global fixed income.

5. Gold and Gold Mining Stocks (GLD, GDX): In an environment of inflation above target, expectations for further rate cuts, and a weakening dollar, gold is expected to continue rising. The Bank of America Global Commodities Research team has set a target price of $4,000 per ounce. Based on the relationship between price and fund inflows, gold ETFs are "missing" about $55 billion in potential inflows. Central banks are in the longest period of gold purchases, and gold mining stocks have a beta of 1.5 to gold, with the North American metals team predicting free cash flow will rise from $19 billion in 2025 to $29 billion in 2026