Equity markets could come under further pressure ahead of a U.S. Federal Reserve rate hike, according to UBS Global Research.
In an analysis note, UBS said bond markets are increasingly reflecting the potential for growth to accelerate in the U.S., thereby giving the Fed more wriggle room to resume tightening.
"Over the last two weeks, two- year (bond) rates jumped from 0.7 percent to 0.9 percent roughly. Stronger growth leading rates higher and curves steeper is a key component of our views," UBS said.
However, for the move to stick, UBS stresses that the equity markets also need to rally. However, stocks around the world, reeling from plunging commodity prices, weaker-than-expected corporate earnings results and political events, seem fearful of an earlier-than-expected hike.
UBS warns that the next hike may not trigger as much of an explosion in financial conditions, especially if the Fed is patient enough until a rebound in global growth limits dollar strength.
"Less dollar strength would support oil prices. And less oil weakness would also reduce the downside in US credit. But we are not there yet: markets are still quite pessimistic on growth outside the US, given the ongoing weakness in China-growth-sensitive asset," the research said, adding, that if the Fed forced rate hikes, there is a risk of sell-off in risky assets which could deliver tightening equivalent to a full cycle.
The latest minutes released from the Fed show the central bank will likely raise interest rates in June if economic data points to stronger second-quarter growth as well as firming inflation and employment.
"Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor markets continued to strengthen, and inflation making progress toward the committee's 2 percent objective, then it likely would be appropriate for the committee to increase the target range for the federal funds rate in June," according to the minutes.
While equities around the world are feeling the pressure, U.K. equities in particular are seeing tough times in the run-up to the country's referendum on its membership of the European Union. In a recent survey conducted by Bank of America Merrill Lynch, global fund managers have been avoiding U.K stocks on fear that the equity sector may get badly impacted. The survey showed that fund allocations to UK equities fell to their lowest levels since November 2008.
Investors surveyed said they considered Brexit to be their biggest "tail-risk" this summer. However, nearly 71 percent say Brexit is "unlikely" or "not at all likely."