To The Moon

Strategists at Bank of America, led by Michael Hartnett, are cautioning that the recent sharp surge in U.S. Treasury market volatility is amplifying the risk of broader deleveraging across financial markets.

Amid a fierce selloff in Treasuries, the MOVE index, which tracks expected volatility in the U.S. government bond market, has jumped roughly 35% in just two trading sessions, signaling mounting pressure on a financial system that relies heavily on Treasuries as collateral.

In a report released on Friday, Hartnett noted that if elevated bond market volatility coincides with further declines in financial stocks, it could serve as a trigger for a wider selloff in risk assets.

Specifically, he identified two key levels to watch: if a global financial stock index falls below 125 while the MOVE index remains above 125, markets could face a more pronounced "risk-off" shock.

MOVE Index Surges 35% in Two Days as Treasury Market Stress Builds Rapidly

The MOVE index is widely regarded as the "bond market fear gauge," measuring expected volatility in the U.S. Treasury market. Recently, Treasury prices have fallen sharply and yields have climbed rapidly, significantly amplifying bond market volatility.

Hartnett argues that what is alarming is not just the high level of yields themselves, but the speed of the market move. If bond prices fall quickly, it could force investors who use Treasuries as collateral and employ leverage to reduce positions, creating a chain reaction: falling bond prices lead to margin calls or forced deleveraging, which in turn triggers further asset sales.

This is the broader deleveraging risk that Bank of America is concerned about. In fact, in the bank's fund manager survey released earlier this month, "disorderly rises in bond yields" was already cited by investors as the biggest tail risk facing markets.

Hartnett also raised another scenario worth watching: if oil prices decline following a U.S.-Iran agreement but bond yields continue to climb, it could suggest that the forces driving yields higher are not solely tied to energy inflation, potentially pushing markets into a different risk-off environment.

Continued Yield Increases Remain the Primary Threat to Economic Expansion

In Bank of America's base case, persistently rising bond yields remain the main market risk to the current economic expansion. Sustained higher interest rates not only raise government and corporate financing costs but also push up borrowing costs such as mortgages and weigh on equity valuations.

This is particularly relevant given elevated U.S. equity valuations and the highly concentrated weight of AI-related stocks. A rapid rise in yields could further compress valuation room for high-priced assets.

However, Hartnett believes policymakers are unlikely to allow yields and energy prices to rise indefinitely. He argues that the U.S. stock market has grown so important that policymakers cannot afford to ignore it. Therefore, if bond yields and oil prices continue to rise and significantly impact markets, the government may take steps to curb them, and such policy intervention could ultimately weigh on the dollar.

Recommendation: Hold Commodities and Emerging Market Assets, Wait for Yields to Peak

In this market environment, Bank of America advises investors to continue holding commodities and emerging market assets while looking for opportunities that may emerge once bond yields peak.

Hartnett believes that once yields reach a peak, a range of rate-sensitive assets—including 30-year U.S. Treasuries, mega-cap tech stocks, small-cap stocks, biotech stocks, and real estate stocks—could present allocation opportunities.

The logic behind this approach is that current high yields are suppressing longer-duration bonds and sectors sensitive to financing costs. If policy intervention or easing inflation pressures eventually cause yields to stop rising or even decline, these assets that have been hardest hit by rate shocks could regain support.

"AI Big 10" Now Accounts for 41% of U.S. Equity Weight, Market Concentration Draws Attention

Hartnett also pointed out that the U.S. stock market is currently highly concentrated in a handful of large AI-related technology companies, which could amplify the impact of bond market shocks on equities.

His definition of the "AI Big 10" includes the "Magnificent Seven" plus Broadcom (AVGO.US), AMD (AMD.US), and Micron Technology (MU.US). Together, these companies now account for roughly 41% of total market weight.

Bank of America notes that this concentration is roughly comparable to extreme levels seen near previous market peaks in 1973, 1989, and 2000. This means that if bond yields continue to rise rapidly and high-valuation AI and tech assets experience a significant correction, their large index weights could further amplify overall stock market volatility.

Where Will Markets Head by Year-End? BofA Outlines Bullish and Bearish Scenarios

Beyond the base case, Hartnett also outlined two extreme market paths that could unfold by the end of this year.

In one scenario, if U.S. political dynamics create checks and balances, oil prices decline, and bond yields hit a ceiling, financial conditions could ease, and AI and consumer-related sectors could continue to perform strongly.

The other scenario involves policy changes following the U.S. midterm elections. If the election results trigger a repricing of fiscal and policy outlooks in the bond market and cause a historic Treasury selloff, the highly concentrated U.S. stock market could face a significant shock.

However, these are scenario analyses proposed by Hartnett and not Bank of America's base forecasts. His core warning remains focused on the bond market. With the MOVE index surging sharply in a short period and Treasury yields staying elevated, investors need to watch whether bond market volatility further transmits to financial stocks and other risk assets, and ultimately escalates into a broader deleveraging event.