Bank of America Identifies Significant Bond Market Demand Risk from Declining Equity Rebalancing Flows

Bank of America’s research highlights a fundamental but often overlooked structural support for bond markets: the portfolio rebalancing behavior of large institutional investors, particularly those managing balanced portfolios with equity and fixed-income allocations [1][2]. When equity portfolios appreciate significantly, institutional investors routinely sell equities and purchase bonds to maintain their target asset allocations—a mechanism that has functioned as a consistent source of bond demand since 2021.

The significance of this flow becomes apparent when quantified: BofA strategists estimate that portfolio rebalancing accounts for

and over the recent period [2]. Based on approximately $10 trillion in assets under management, this translates to roughly in portfolio rebalancing outflows from equities into bonds [2]. This structural demand has been particularly important during periods of equity market strength, creating a self-reinforcing mechanism that supports bond prices when equities appreciate.

The risk identified by BofA stems from two converging factors that are expected to substantially reduce the magnitude of these rebalancing flows in 2026. First, the strategists project

for the S&P 500 at approximately —a figure notably below historical average annual returns [2]. When equity appreciation is limited, the imperative to rebalance by selling equities and purchasing bonds diminishes proportionally, as portfolio drift from target allocations becomes less pronounced.

Second, the Federal Reserve’s anticipated policy path suggests

[2], representing a more restrained easing cycle than what some market participants may have priced in. The combination of limited monetary policy accommodation and moderate equity returns creates an environment where the “rebalancing engine” that has driven duration demand over the past five years may significantly recede in strength. BofA strategists characterize this as one of the “most reliable drivers of duration demand over the past five years may recede” [2].

The 10-year Treasury yield currently trades around

[0], reflecting an elevated rate environment relative to the lows experienced during 2024. This yield level places Treasuries in a context where price sensitivity to demand shifts becomes more pronounced—particularly for longer-duration securities. The S&P 500 closed at , registering a +1.70% gain on the day [0], demonstrating continued equity market resilience despite valuation concerns that may contribute to the moderated return expectations cited by BofA.

The correlation regime between bonds and equities has become elevated during this period, which BofA identifies as both a symptom and a potential amplifier of the rebalancing dynamics [2]. When equities rise and investors rebalance into bonds, the resulting bond purchases create positive correlation between asset classes during rallies. A slowdown in rebalancing activity could normalize these correlations, potentially improving the hedging properties of long-duration bonds but also introducing transitional volatility as markets adjust to a new demand dynamic.

The BofA analysis reveals a critical structural vulnerability in the current bond market framework that extends beyond cyclical considerations. The portfolio rebalancing mechanism represents a

that has functioned consistently regardless of the broader interest rate environment—making its potential diminishment a distinct risk factor separate from monetary policy expectations or fiscal supply considerations. Investors and market participants should recognize that this risk emerges from the rather than from credit fundamentals or issuer behavior.

The quantified impact of rebalancing flows—14% of Treasury and 22% of investment-grade bond supply absorption—positions this as a

rather than a marginal factor [2]. A meaningful slowdown would require other buyer categories to absorb the resulting excess supply, potentially pressure yields higher and prices lower across the affected securities. The concentration of this demand source among institutional investors managing large balanced portfolios means the adjustment could be relatively synchronized rather than gradual.

An important secondary insight from the BofA analysis concerns the potential

should rebalancing flows diminish [2]. The elevated bond-equity correlation regime has historically reduced the portfolio diversification benefit of holding longer-duration Treasuries, as both asset classes have shown tendency to move together during certain market regimes. A normalization of correlations could restore the traditional defensive characteristics of high-quality bonds, potentially altering risk-premia calculations across multi-asset portfolios.

This dynamic introduces a nuanced consideration: while the direct impact of reduced rebalancing demand may be negative for bond prices in the near term, the resulting correlation shifts could enhance the portfolio construction value of duration exposure over time. The net effect would depend on the magnitude and persistence of the rebalancing slowdown, as well as the specific market conditions that trigger the correlation regime change.

The identification of rebalancing flows as a key demand driver suggests that

will be an important factor to monitor in 2026. If equity returns prove even more modest than the 4.5% projection, or if the Fed signals an even more gradual easing path, portfolio managers may adjust their rebalancing thresholds or target allocations—potentially accelerating the demand reduction. Conversely, stronger-than-expected equity performance would trigger more aggressive rebalancing and temporarily reinforce the bond demand support.

The

of this dynamic warrants particular attention: institutional investors may internalize the BofA analysis and adjust their expectations for rebalancing-induced demand, potentially altering their own trading behavior in a manner that either amplifies or moderates the identified risk. This reflexive interaction between market analysis and participant behavior represents a nontrivial variable in forecasting the actual market impact.

1. Demand Compression and Yield Pressure
   : The most immediate risk is that reduced rebalancing flows will leave a meaningful gap in bond demand that other buyer categories may struggle to fill. This is particularly relevant for the Treasury market, where foreign official demand has shown variability and domestic retail demand remains interest-rate sensitive. A 14% reduction in absorption capacity for Treasuries [2] represents a significant supply-demand imbalance that could manifest as yield elevation and price depreciation.

2. Duration Exposure Sensitivity
   : Investors with substantial duration exposure in fixed-income portfolios face potential mark-to-market losses if the rebalancing thesis plays out as BofA anticipates. The 10-year yield at 4.21% [0] provides limited cushion against adverse price movements, meaning modest yield increases could produce meaningful total return drag for duration-sensitive strategies.

3. Transitional Volatility
   : The adjustment to a lower-rebalancing regime may introduce
   correlation regime volatility
   as markets discover new equilibrium pricing. BofA’s observation that the rebalancing engine has pushed bond-equity correlations higher [2] suggests that correlation normalization could be disorderly rather than gradual, potentially affecting options markets and risk-parity strategies that depend on historical correlation assumptions.

1. Duration Value Emergence
   : If reduced rebalancing flows trigger yields higher and prices lower, patient investors may find attractive entry points for long-duration exposure at yield levels that incorporate the demand reduction premium. The fundamental attraction of Treasuries as risk-free assets and the ultimate anchoring role of Fed policy may support prices at levels that incorporate excessive near-term pessimism.

2. Correlation Arbitrage
   : Should correlations normalize as rebalancing flows diminish, strategies that benefit from bond-equity dispersion could become more viable. Long-duration bonds may once again serve as effective portfolio hedges during equity stress, restoring a structural demand source that has been compressed during the elevated correlation regime.

3. Relative Value in Investment-Grade Corporates
   : The 22% absorption of investment-grade bond supply by rebalancing flows [2] exceeds the Treasury percentage, suggesting that corporate bonds may face proportionally greater demand pressure. This could create relative value opportunities between Treasuries and investment-grade corporates, with potential for spread widening that may eventually prove attractive at higher yield levels.

The identified risks are

, with the most significant impacts expected to materialize as 2026 unfolds and the projected moderate equity returns and limited Fed easing become operational realities. The (Q1 2026) represents a critical monitoring period, as actual rebalancing flow data will provide the first validation of BofA’s thesis.

Key catalysts to watch include:

• S&P 500 performance relative to the 4.5% projection
  : This serves as a leading indicator for rebalancing strength
• Fed meeting outcomes and guidance
  : Changes to the expected two-rate-cut trajectory would significantly alter the analysis
• Actual Treasury and IG bond demand metrics
  : Monthly data will validate or challenge BofA’s quantified estimates

The risk level should be characterized as

—sufficient to warrant monitoring and portfolio preparation, but not demanding immediate defensive positioning absent confirming market data.

The Bank of America analysis provides a well-quantified framework for understanding a structural bond market support mechanism that may diminish in 2026. Portfolio rebalancing flows have absorbed approximately 14% of Treasury issuance and 22% of investment-grade corporate bond supply since 2021, translating to roughly $37 billion per month in flows from $10 trillion of managed assets [2]. Projected modest equity returns (S&P 500 +4.5%) and limited Fed easing (2 rate cuts) are expected to reduce this demand source, potentially creating headwinds for bond prices and altering correlation dynamics.

The current market context features a 10-year Treasury yield around 4.21% [0] and an elevated bond-equity correlation regime that BofA associates with rebalancing activity. A normalization of correlations could improve the hedging properties of long-duration bonds but may introduce transitional volatility. Investors should monitor actual rebalancing flow data, equity market trajectory relative to projections, and Fed policy guidance as the 2026 year unfolds.

The information synthesized in this analysis is based primarily on Bank of America Global Research findings reported via MarketWatch and Morningstar on February 9, 2026 [1][2], supplemented by internal market data for current yield and index levels [0]. The analytical framework provided by BofA offers a structured approach to evaluating a distinct structural risk factor, though actual market outcomes will depend on the interplay between projected conditions and emerging data.