U.S. Treasury bonds are experiencing a wave of large-scale selling, with long-end yields soaring to their highest levels in over a decade. Concerns about a resurgence in inflation are prompting investors to reassess the Federal Reserve's interest rate hike outlook, and this intense volatility is beginning to spill over into the U.S. stock market. During early U.S. trading on Tuesday, 5-year and 10-year Treasury futures faced a concentrated wave of block selling, equivalent to approximately $15 billion in 10-year spot Treasury bonds. Under this pressure, the yield on the 30-year Treasury rose 5 basis points to 5.18%, reaching its highest level since the eve of the 2007 global financial crisis.
Alan Taylor, Founding Partner of Archr LLP, described it as a day of "capitulation" for U.S. Treasuries, noting that the presence of multiple large sellers accelerated the selling process. The sharp volatility in the bond market quickly spread to equities. Small-cap stocks, which are more sensitive to interest rates and oil prices, bore the brunt of the selloff, with the Russell 2000 index falling 1.6%. In contrast, the tech-heavy Nasdaq 100 index declined less than 0.9%, and the S&P 500 index dropped 0.7%. After the market decline, bargain-hunting emerged. Following the European market close, buyers of 0DTE call options actively entered the market, briefly pulling the Nasdaq index back near its opening level. The immediate trigger for this selloff was the surge in energy prices driven by geopolitical conflict, which heightened market concerns about inflation. The interest rate futures market now reflects an 85% probability of a Fed rate hike by year-end, whereas on May 1st, market pricing suggested a near-zero chance. Persistently rising yields threaten the resilience of the U.S. economy and are increasing borrowing costs for businesses and homebuyers.
Futures Market Hit with Billions in Sell Orders, Short Positions Extremely Extended The block trades that triggered Tuesday's market shock occurred during an exceptionally frenetic trading session. From approximately 9:38 AM to 10:40 AM New York time, the market faced sustained selling pressure. Within this roughly one-hour window, a total of 136,500 10-year Treasury futures and 83,000 5-year Treasury futures were sold via block trades. The trading volume for 10-year Treasuries was about 80% above its 20-day average. These trades were distributed across ten block orders, with a combined risk weight per basis point of around $12 million. Although Tuesday's selling was partly driven by the unwinding of long positions, the market's overall positioning in recent sessions has become increasingly and clearly skewed towards bearishness. David Bieber, a strategist at Citi, noted that the market has significantly added new short risk over the past five days, with current short positions in a state of "extreme extension" both tactically and structurally. The options market similarly confirms this pessimistic sentiment. According to JPMorgan's U.S. Treasury client survey, as of the week ending May 18th, outright short positions remained at their highest level in over three months. Furthermore, the cost of hedging via options on the long end of the yield curve has shown a clear bias towards put options over the past week, marking the largest shift since late March.
Inflation Fears Rekindled, Stock-Bond Correlation Hits Rock Bottom Subtle shifts in the macroeconomic backdrop are the core driver behind the bond market's repricing. Charlie McElligott of Nomura pointed out that investors are refocusing on accelerating inflation, primarily due to shocks to energy supply chains, rapidly depleting emergency inventories, and risk signals of "overheating" emanating from the demand side of the U.S. economy. This dynamic has led to a re-pricing of global central bank policy paths in a more "hawkish" direction. Against this backdrop, the pace of rising bond yields is approaching the tolerance limit for the stock market. Goldman Sachs data shows that when the 10-year Treasury yield rises by 40 basis points within a month, the stock market typically begins to experience significant impact. The current increase in that yield has already reached 38 basis points. Peter Callahan of Goldman Sachs summarized that the relationship between stocks and bond yields has changed dramatically over the past two months, with their negative correlation reaching its highest level since the 1990s.
Bargain Hunting Emerges After Stock Drop, Divergence Between Small-Caps and Tech Widens Under the shadow of high interest rates and high oil prices, the U.S. stock market is diverging into two distinct tracks: one dominated by large companies benefiting from the artificial intelligence boom, and the other composed of small and medium-sized enterprises more sensitive to the macroeconomy. Mandy Xu, Head of Derivatives Market Intelligence at Cboe Global Markets, stated that small and mid-cap stock indices are the first area to see a rebound in hedging demand over the past six weeks. She noted that tighter monetary policy typically weighs more heavily on small-cap stocks. In contrast, the relative demand for put options on the S&P 500 index remains moderate, with market optimism towards large-cap tech stocks still supporting the broader market. Faced with the weakness in small-caps, some investors are adopting protective strategies. Alexis Maubourguet, Founder of Adapt Investment Managers, employs a put ratio spread strategy to construct asymmetric positions that limit downside risk. Brent Kochuba, Founder of SpotGamma, favors buying call options on the Cboe Volatility Index (VIX). He believes the VIX could likely break above 20 if geopolitical tensions worsen. However, after the European market close, buyers of 0DTE call options actively entered the market, briefly pulling the Nasdaq index back near its opening level. Goldman Sachs' TMT Momentum basket rebounded by as much as 10% after hitting its intraday low, having previously fallen 22% over three trading days. Yet, as negative delta flows from 0DTE options reasserted dominance into the close, the major indices turned lower again, ultimately finishing in negative territory.
AI Frenzy Faces Reality Check, Market Focus Shifts to Core Earnings Investors are locking in profits ahead of tech company earnings reports. The market focus is shifting from the sheer strength of AI demand to more practical challenges related to profitability discipline, such as capacity constraints and rising input costs. According to analysis by Bloomberg strategist Michael Ball, the speed of AI demand growth is misaligned with data center construction cycles, and data centers are facing cost pressures. Data provided by Ananth Muniyappa of Oppenheimer shows that the average token cost for large language models (LLMs) has surged 65% since late February to $2.12 per million tokens, increasing the risk that end-users may limit usage or delay deployment. In this context, Nvidia's earnings report is not only a test of its own profitability but also a stress test for the broader AI narrative. McElligott of Nomura warned that as VIX option expiration and Nvidia's earnings report approach, market makers are becoming increasingly reluctant to price risky assets, and the market needs to be wary of potential negative convexity issues and a sharp amplification of volatility. Although JPMorgan's Market Intelligence desk maintains a "tactically bullish" stance due to factors like macro fundamentals and corporate buybacks, it has also clearly highlighted short-term risks stemming from rising bond volatility and potential exhaustion in AI momentum.
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