U.S. Treasury Bonds Perform a "Surrender-Style Massive Sell-Off" as High-Interest Rate Shadow Looms Over the Stock Market

Author: Ye Zhen, Wall Street Insights

U.S. Treasuries face a massive sell-off wave, with long-term yields soaring to their highest levels in over a decade, while concerns over inflation rebound are prompting investors to reassess the Federal Reserve's rate hike outlook. This intense volatility has begun to transmit to the U.S. stock market.

On Tuesday morning in the U.S., 5-year and 10-year Treasury futures experienced a wave of heavy block selling, equivalent to about $15 billion worth of 10-year spot Treasuries. Under this pressure, the 30-year Treasury yield rose 5 basis points to 5.18%, reaching the highest level since just before the 2007 global financial crisis.

Alan Taylor, founding partner of Archr LLP, said this is "America's surrender day" for Treasuries, and the appearance of multiple large sellers has accelerated this sell-off.

The sharp volatility in the bond market quickly spilled over into equities. Small-cap stocks, which are more sensitive to interest rates and oil prices, led the decline, with the Russell 2000 down 1.6%; in contrast, the tech-heavy Nasdaq 100 fell less than 0.9%, and the S&P 500 declined 0.7%. After the stock market fell, some bottom-fishing funds appeared; after European markets closed, 0DTE call option buyers actively entered, temporarily pushing the Nasdaq back near flat.

The direct trigger for this sell-off was the surge in energy prices caused by geopolitical conflicts, which intensified market fears of inflation. The interest rate futures market currently reflects an 85% probability that the Fed will raise rates by the end of the year, whereas on May 1, the market was pricing in no rate hikes. The rising yields threaten the resilience of the U.S. economy and increase borrowing costs for companies and homebuyers.

Futures market sees hundreds of millions in sell orders, with extreme expansion of short positions

The massive block trades that caused market turmoil on Tuesday occurred during an extremely frenetic trading session.

From around 9:38 to 10:40 a.m. New York time, the market experienced continuous selling pressure. In about an hour, 136.5k contracts of 10-year Treasury futures and 83k contracts of 5-year Treasury futures were sold via block trades, with the 10-year volume about 80% above its 20-day average. These trades were spread across ten large orders, with an aggregate risk weight of approximately $12 million per basis point.

Although part of Tuesday’s sell-off stemmed from long positions being closed, overall market positioning in recent days has increasingly tilted toward bearishness. Citi strategist David Bieber noted that over the past five days, the market has significantly increased new short risk, and current short positions are "extremely expanded" both tactically and structurally.

Options markets also confirm this pessimistic sentiment. According to JPMorgan’s survey of U.S. Treasury clients, as of the week ending May 18, absolute short positions remain at their highest in over three months. Additionally, hedging costs for long-dated options on the yield curve have shifted markedly toward puts over the past week, reaching the largest change since late March.

Inflation fears rekindle, stock-bond correlation drops to a low

Subtle shifts in macroeconomic context are the core drivers behind bond market re-pricing.

Charlie McElligott of Nomura pointed out that investors are refocusing on accelerating inflation, mainly due to shocks to energy supply chains, rapid depletion of emergency inventories, and signals of "overheating" in U.S. demand. This pattern is causing global central banks to reprice their policy paths as more "hawkish."

Against this backdrop, the speed of rising bond yields has approached the tolerance limit of equity markets. Goldman Sachs data shows that when the 10-year Treasury yield rises 40 basis points within a month, stocks typically begin to experience significant impacts. Currently, the yield has increased by 38 basis points.

Goldman’s Peter Callahan summarized that over the past two months, the relationship between stocks and bond yields has changed dramatically, with their negative correlation reaching the highest level since the 1990s.

Stock market rebounds after declines, with widening divergence between small caps and tech

Under the shadow of high interest rates and high oil prices, the U.S. stock market is splitting into two very different tracks: one dominated by large companies benefiting from the AI boom, and the other composed of small and mid-sized firms more sensitive to macroeconomic conditions.

Mandy Xu, head of derivatives intelligence at Cboe Global Markets, said that the small-cap index is the first area in six weeks to show a resurgence in hedging demand. She noted that monetary tightening often weighs more heavily on small caps. In contrast, the relative demand for puts on the S&P 500 remains moderate, and optimism about large tech stocks continues to support the broader market.

Faced with weakness in small caps, some investors are adopting protective strategies. Alexis Maubourguet, founder of Adapt Investment Managers, is using put ratio spreads to build asymmetric positions to limit downside risk. Brent Kochuba, founder of SpotGamma, prefers buying call options on the Cboe Volatility Index (VIX). He believes that if geopolitical tensions worsen, the VIX could break above 20.

However, after European markets closed, 0DTE call buyers actively entered, temporarily pushing the Nasdaq near flat. Goldman Sachs’ TMT momentum basket rebounded up to 10% from its intraday lows, after falling 22% over the previous three trading days. Yet, as 0DTE negative delta flows reasserted dominance late in the session, major indices declined again, closing lower.

AI frenzy faces real-world test, markets focus on core earnings reports

Investors are locking in profits ahead of tech earnings releases. The market’s focus is shifting from mere AI demand strength to more tangible profitability discipline issues such as capacity constraints and rising input costs.

Bloomberg strategist Michael Ball analyzed that the growth rate of AI demand is misaligned with the data center build cycle, which is also under cost pressures. Data from Oppenheimer’s Ananth Muniyappa shows that the average token cost for large language models (LLMs) has surged 65% since late February, reaching $2.12 per million tokens, increasing the risk of end users limiting usage or delaying deployment.

In this context, Nvidia’s earnings are not only a test of its own profitability but also a stress test for the entire AI narrative. Nomura’s McElligott warned that with VIX options nearing expiration and Nvidia’s earnings approaching, market makers are increasingly reluctant to price high-risk assets, raising the potential for negative convexity and sharp volatility spikes.

Although JPMorgan’s macro and corporate buyback teams maintain a "tactically bullish" stance, they also highlight short-term risks from rising bond volatility and the exhaustion of AI momentum.