US Treasury volatility surges, triggering alarms! BofA’s Hartnett warns of rising deleveraging risks as higher yields become main threat to the market

According to Zhitong Finance APP, Bank of America strategist Michael Hartnett has warned that the recent sharp spike in volatility in the U.S. bond market is increasing the risk of a broader deleveraging in financial markets. Amid heavy sell-offs of U.S. Treasuries, the MOVE index—which measures expected volatility in the U.S. Treasury market—has surged about 35% in just two trading sessions, indicating greater pressure on the financial system that uses U.S. Treasuries as collateral.

In a report released on Friday, Hartnett pointed out that if high bond market volatility coincides with a further decline in financial stocks, this could serve as a signal triggering a more widespread sell-off in risk assets.

Specifically, he identified two key levels as monitoring indicators: if the global financial stocks index falls below 125 while the MOVE index remains above 125, the market could face a more pronounced "flight to safety" shock.

MOVE Index Soars About 35% in Two Days—Pressure Rapidly Building in U.S. Bond Market

The MOVE index is often viewed as the "bond market fear index" and is used to gauge expected volatility in the U.S. Treasury market. Recently, U.S. Treasury prices have plummeted and yields have surged, significantly amplifying bond market volatility.

Hartnett believes that the concern is not just the high level of yields themselves, but also the speed at which market moves are happening. If bond prices fall quickly, investors using U.S. Treasuries as collateral and employing leverage may be forced to cut their positions, triggering a chain reaction of "bond market declines—margin calls or deleveraging—further asset sales."

This is at the heart of Bank of America's concern over a broader deleveraging risk. In fact, in Bank of America's earlier fund manager survey this month, "disorderly rises in bond yields" had already been identified by investors as the biggest tail risk currently facing the market.

Hartnett also outlined another scenario worth watching: if oil prices fall after a U.S.-Iran agreement, but bond yields continue to climb, it could suggest that forces driving yields higher are not limited to energy inflation, possibly sending the market into a different kind of risk-averse environment.

Continued Rise in Yields Is the Main Threat to Economic Expansion

In Bank of America's base case, persistently rising bond yields remain the main market risk facing the ongoing economic expansion.

Persistently high rates not only mean higher financing costs for governments and companies but also raise borrowing costs such as mortgages, putting pressure on stock valuations. Especially in today's high-valuation U.S. equity market, where AI-related stocks carry significant weight, a rapid rise in yields may further squeeze the valuation of these high-priced assets.

However, Hartnett believes policymakers are unlikely to allow yields and energy prices to rise indefinitely.

Hartnett argues that the significance of the U.S. stock market has reached a level that policymakers can hardly ignore. Therefore, if U.S. Treasury yields and oil prices continue to rise and exert significant pressure on the market, the government is likely to intervene, and such policy intervention may ultimately put downward pressure on the U.S. dollar.

Advises Holding Commodities and Emerging Market Assets and Waiting for Yield Peak Opportunities

In this market environment, Bank of America recommends that investors continue to hold commodities and emerging market assets while seeking opportunities that may arise after bond yields peak.

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

The logic behind this view is that currently high yields are suppressing long-duration bonds and equity sectors sensitive to financing costs. If policy intervention or easing inflation pressures eventually halt or reverse the rise in yields, these rate-impacted assets could regain support.

"AI Big 10" Weight in U.S. Stocks Rises to 41%—Market Concentration Draws Attention

Hartnett also pointed out that the U.S. stock market is currently highly concentrated in a handful of major AI-related technology companies, which could amplify the impact of bond market shocks on equities. His definition of the "AI Big 10" includes the "Tech Seven," as well as Broadcom (AVGO.US), AMD (AMD.US), and Micron Technology (MU.US). The combined market weight of these firms has now reached about 41%.

Bank of America notes that this level of concentration is close to the extreme levels seen around previous market peaks in 1973, 1989, and 2000. This implies that if bond yields continue to rise rapidly, a marked correction in high-valuation AI and tech assets could further magnify overall stock market volatility due to their large index weights.

Where Is the Market Headed by Year-End? Bank of America Maps Out Bull and Bear Scenarios

In addition to the base case, Hartnett listed two potential extreme market paths for the end of this year. In one scenario, if the U.S. political landscape reaches a compromise, oil prices decline, and bond yields hit a ceiling, financial conditions could ease, with AI and consumer-related sectors continuing to perform strongly.

The other scenario involves policy changes after the U.S. midterm elections. If election outcomes prompt the bond market to reprice fiscal and policy outlooks, leading to an historic sell-off in U.S. Treasuries, the highly concentrated U.S. stock market could face a significant shock.

However, these are Hartnett's scenario analyses and not Bank of America's base forecast. His core warning remains focused on the bond market: with the MOVE index surging sharply in a short period and U.S. Treasury yields staying elevated, investors need to watch whether bond market volatility spreads to financial stocks and other risk assets, ultimately evolving into a broader wave of deleveraging.