Bank of America has put the Federal Reserve on notice. Its economists see danger in the central bank’s current approach to communication and policy signals. The lack of clear forward guidance from Chair Kevin Warsh leaves markets guessing. That guesswork carries a price.

Higher Treasury yields act like a tax on growth. Mortgages cost more. Businesses borrow at elevated rates. Consumers feel the pinch in everything from home loans to credit cards. The strategy risks self-inflicted harm. So says the bank’s analysis of recent Fed moves.

The warning comes at a delicate moment. Inflation has proven sticky. Geopolitical tensions flare in the Middle East. Consumers show signs of strain yet have held up better than many expected. But Bank of America now forecasts three quarter-point rate hikes in 2026. The call stands among the most hawkish on Wall Street. It reflects a view that policy must stay tight longer to stamp out price pressures fueled by tariffs and supply disruptions.

Aditya Bhave and Mark Cabana at the bank laid out the case in recent notes. They argue the Fed’s vagueness on its reaction function erodes credibility. What inflation gauges does it watch most closely? How much deviation from the 2% target will it tolerate and for how long? Without answers, risk premiums rise. Yields climb further. The economy pays.

Mark Zandi of Moody’s Analytics echoed similar concerns in related commentary. He pointed to the bond market’s independent tightening after the Fed’s July 29 meeting. Warsh himself noted sharp moves in Treasury yields even as the central bank held its benchmark rate steady between 3.50% and 3.75%. Yet BofA sees this not as helpful self-correction but as a symptom of policy confusion that could slow activity.

But the bank’s message doesn’t stop at monetary matters. CEO Brian Moynihan recently highlighted risks from leverage and sky-high valuations. He pointed to the near-collapse of the AI-focused hedge fund Situational Awareness as a clear signal. “These are all warning shots,” Moynihan told CNBC. “Valuations get out, leverage in the system gets there. You have to be careful.”

The comment came days after the fund faced massive margin calls and a fire sale averted only by intervention from Citadel. Moynihan suggested banks should respond by tightening underwriting standards slightly. The episode serves as reminder that borrowed money amplifies moves in both directions. When sentiment shifts, the unwind can turn vicious.

Investors have grown complacent. The latest Bank of America fund manager survey shows bullishness at levels not seen since 2021. Recession odds sit near zero in some betting markets. Only 2% of respondents see a hard landing. A record 54% now bet on a “no landing” scenario where growth stays strong without inflation reigniting. Such optimism worries the bank’s strategists.

Michael Hartnett, chief investment strategist, has flagged multiple threats. He sees summer market upside as limited and warns of seasonal weakness in August. Bond yields could spike further on events ranging from fiscal debates to geopolitical shocks. In one note he outlined a scenario where 30-year yields push toward 5% in the U.S. That would pressure equities hard. The S&P 500 already sits 5% off its peak earlier this year.

Consumer behavior holds the key. Moynihan has said repeatedly that a pullback in spending would slow the entire economy. Early signs appear in rising 401(k) withdrawals and softening savings rates. Energy costs climb amid Middle East conflicts. Real wages turned negative in recent months. These pressures build even as payroll growth stabilizes around 1.4% year-over-year according to internal Bank of America data.

The bank’s private bank arm paints a picture of resilience mixed with vulnerability. Chris Hyzy, chief investment officer for Merrill and the private bank, notes that fiscal and monetary support should prevent recession. Corporate profits look intact. Yet he cautions that uncertainties from wars and market volatility will test that support. BofA now expects no rate cuts until at least mid-2027. The pivot from earlier forecasts of two cuts this year shows how data has altered the outlook.

Sticky services inflation adds another layer. Artificial intelligence-driven capital spending and energy prices both feed into core measures. The combination makes the Fed’s job harder. Warsh’s reluctance to spell out thresholds leaves traders to fill the void with their own assumptions. That dynamic lifts the entire yield curve. Borrowing costs across the economy follow.

Comparisons to past tightening cycles surface often in these discussions. Some recall 2008 signals that Hartnett has mentioned in other contexts. Oil prices near triple digits. Private credit expansion. Leveraged positions across hedge funds and beyond. The Situational Awareness episode fits that pattern. It wasn’t systemic. Bank of America itself would have been fine. Yet it revealed how quickly liquidity can evaporate when confidence cracks.

Policy makers face a balancing act. Cut too soon and inflation reaccelerates. Hold firm or even hike and growth suffers from the higher rate environment the bank describes. BofA’s view tilts toward the latter risk. Its economists see the current federal funds rate as insufficiently restrictive given persistent price pressures projected into 2027 and 2028.

Markets price in far less aggression. Futures show only about 6% odds of three hikes. The disconnect creates potential for volatility when economic data lands. Strong employment or inflation prints could force a repricing. Weak numbers might revive cut expectations only to see them dashed again. This yo-yo effect itself damages confidence.

Geopolitics complicates every forecast. Conflicts involving the U.S., Israel, and Iran have already lifted energy costs. Retaliatory strikes ripple through global supply chains. Moynihan listed wars among the top risks for 2026 alongside consumer slowdowns and cyber events. The bank maintains that the U.S. economy can absorb higher rates without tipping into recession. That confidence rests on corporate balance sheets and household savings accumulated during earlier years.

Yet early 2026 offered reminders of fragility. Payroll figures disappointed at times. Inflation readings came in softer before rebounding. The labor market regained footing by March but growth has concentrated in fewer sectors. Revenue visibility suffers as a result. Small and midsize businesses report uneven demand even as hiring stabilizes.

Bank of America itself has adjusted its posture. From warnings about August seasonality to calls for reduced risk exposure, the institution signals caution. Hartnett’s contrarian take on extreme bullishness serves as one example. When sentiment reaches extremes, history suggests mean reversion often follows. Sometimes sharply.

The broader message from the bank blends concern with pragmatism. Learn from episodes like the hedge fund scare. Adjust standards incrementally. Recognize that valuations and leverage have run far. Prepare for an environment where the Fed communicates less rather than more. Accept that this opacity imposes real costs.

Investors would do well to listen. The S&P 500’s year-to-date decline of nearly 3% already reflects some of these pressures. Further yield increases could accelerate selling. Or they might not. Much depends on incoming data and how Warsh chooses to clarify the Fed’s path. For now the uncertainty persists. And markets keep paying the price.