US Treasury volatility spikes, sounding alarm! BofA's Hartnett warns of rising deleveraging risk, with rising yields becoming the main threat to the market.

Bank of America Corp strategist Michael Hartnett warned that the recent sharp rise in U.S. bond market volatility is increasing the risk of broader deleveraging across financial markets. As U.S. Treasuries came under heavy selling pressure, the MOVE index, which measures expected volatility in the U.S. Treasury market, surged about 35% in just two trading sessions, signaling that the financial system relying on U.S. Treasuries as collateral is facing greater stress. In a report released on Friday, Hartnett noted that if high bond market volatility coincides with further declines in financial stocks, it could serve as a signal triggering a broader selloff in risk assets. Specifically, he identified two key levels to watch: if the index tracking global financial stocks falls below 125 while the MOVE index remains above 125, the market could face a more pronounced "risk-off" shock. MOVE Index Surges About 35% in Two Days as Pressure Builds Rapidly in the U.S. Treasury Market The MOVE index is typically viewed as the "bond market fear gauge," used to measure the expected volatility of the U.S. Treasury market. The recent sharp decline in U.S. Treasury prices and rapid rise in yields have significantly amplified bond market volatility. Hartnett believes that what is alarming is not just the high level of yields themselves, but the speed of market changes. If bond prices fall rapidly, it could force investors who use U.S. Treasuries as collateral and employ leveraged trades to reduce positions, creating a chain reaction of "bond market declinemargin calls or leverage contractionfurther asset selling." This is the broader deleveraging risk that BofA is concerned about. In fact, in BofA's fund manager survey released earlier this month, "disorderly rise in bond yields" was already viewed by investors as the biggest tail risk to the market. Hartnett also raised another scenario worth watching: if oil prices fall after a U.S.-Iran deal but bond yields continue to climb, it could mean the forces driving yields higher are not solely from energy inflation, and the market could enter a different risk-off environment. Rising Yields Remain the Main Threat to Economic Expansion In BofA's base case, persistently rising bond yields remain the primary market risk facing the current economic expansion. Sustained higher interest rates not only mean increased financing costs for governments and corporations, but also push up borrowing costs for mortgages and other loans, and weigh on equity valuations. Particularly in an environment where U.S. equity valuations are elevated and AI-related stocks carry highly concentrated weight, a rapid rise in yields could further compress valuation room for high-valuation assets. However, Hartnett believes policymakers may not allow yields and energy prices to rise indefinitely. Hartnett argues that the U.S. stock market has reached a level of importance that policymakers cannot afford to ignore. Therefore, once bond yields and oil prices continue to rise and deal a clear blow to the market, the government may take measures to contain them, and such policy intervention could ultimately put downward pressure on the dollar. Recommendation: Hold Commodities and Emerging Market Assets, Wait for Yield Peak Opportunities In this market environment, BofA recommends investors continue to hold commodities and emerging market assets while looking for investment opportunities that may emerge after bond yields peak. Hartnett believes that once yields reach a peak, a range of rate-sensitive assetsincluding 30-year U.S. Treasuries, mega-cap tech stocks, small-cap stocks, biotech stocks, and real estate stockscould present allocation opportunities. The logic behind this approach is that current high yields are suppressing longer-duration bonds and stock sectors sensitive to financing costs. If policy intervention or easing inflation pressures eventually cause yields to stop rising or even fall back, these assets that have been hit hardest by rate shocks could regain support. "AI Big 10" Weight in U.S. Equities Rises to 41%, Market Concentration Draws Attention Hartnett also noted that the U.S. stock market is currently highly concentrated in a handful of AI-related large-cap tech 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 Inc. (AVGO.US), AMD (AMD.US), and Micron Technology, Inc. (MU.US). Their combined market weight has reached approximately 41%. BofA noted that this concentration is roughly close to extreme levels seen near previous market peaks in 1973, 1989, and 2000. This means that if bond yields continue to rise rapidly, any significant correction in high-valuation AI and tech assets could further amplify overall stock market volatility given their large index weights. Where Will the Market Go by Year-End? BofA Outlines Bull and Bear Scenarios Beyond the base case, Hartnett also laid out 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 after 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 U.S. Treasury selloff, the highly concentrated U.S. stock market could face a significant shock. However, these are scenario analyses proposed by Hartnett and not BofA's base forecast. His core warning remains focused on the bond market. Against the backdrop of the MOVE index surging sharply in a short period and U.S. Treasury yields remaining at elevated levels, investors need to watch whether bond market volatility further transmits to financial stocks and other risk assets, and ultimately evolves into a broader deleveraging episode.