From euphoria to caution: Trade truce rally meets bond market reality

After sprinting from the April abyss to May’s mountaintop, Wall Street’s rally is starting to wheeze at altitude. Despite a barrage of positive Middle East headlines, a China truce, and Gulf money pouring into U.S. assets, equities have hit a wall of technical and likely macro resistance. The S&P 500 tagged its 200dma and positive YTD line—and then promptly encountered the systematic selling brigade, with profit-takers hitting eject simultaneously.

The Nasdaq managed to keep its chin up, riding AI tailwinds and tech resilience, but small caps looked like the dirtiest shirt at the Wall Street Laundy Mart, battered by rate sensitivity and fiscal fears. The VIX nudged higher, sovereign risk blew wider, and traders realized this isn't a victory lap—it’s a breather, maybe even a warning shot.

The truce with China, a new UK trade pact, and high-profile Saudi investment deals helped reset the risk tone. However, the market is now shifting from headlines back to hard economic data—and it might not like what it finds. The transition from doom and gloom to boom was uncanny and lightning-fast, supported by no apparent re-acceleration in growth. As usual, upside momentum requires fundamentals to catch up. The rally didn’t merely price in progress—it priced in perfection. Possible pass-through tariff inflation at the PPI level, released later on Thursday, may not suit that tag of perfection.

Meanwhile, bond markets are sending a very different message—and it’s not one of confidence. Yields are rising for all the wrong reasons. You can draw a straight line from the X-Date for the debt ceiling (conveniently landing near the end of the 90-day tariff pause) to ballooning sovereign credit risk, which now sees short-dated U.S. CDS trading above China and Greece. Let that sink in.

Bond yields are rising steadily—but this isn’t your typical growth-led breakout. It’s the type of yield movement that has traders shifting uncomfortably in their chairs. Here’s what’s really driving the pain trade in Treasuries:

First, bearish option flow is hitting the tape hard. Investors are now wagering on 10-year yields reaching 4.8%, about 30 bps higher than current levels. That’s not a growth bet—it’s a volatility hedge, signalling that big money sees more upside pressure on yields, likely driven by uncertainty rather than economic strength.

At the same time, SOFR markets are pushing Fed rate cut expectations into 2026. The message? The Fed isn’t coming to the rescue anytime soon. With April’s CPI still showing sticky inflation in core consumer categories—particularly shelter, insurance, and services—the disinflation narrative has softened. And with PPI on deck Thursday, traders are bracing for signs of tariff pass-through creeping into producer costs. That keeps the Fed sidelined and rate cut hopes on ice.

The result? Bond prices take the hit.

But it’s not just macro. There’s a positioning squeeze unfolding, too. Many bond investors who chased longs into the CPI miss are now underwater, especially at the long end of the curve. That opens the door for systematic short sellers to press their advantage, exacerbating the move and forcing weak hands out.

On top of that, there is a growing concern about how Trump’s ambitious tax plan will be financed, and you’ve got a sovereign risk premium sneaking into the picture. Bond traders aren’t just worried about inflation or rates—they’re questioning the fiscal roadmap. With the X-Date for the debt ceiling hovering near the end of the tariff pause window, the political risk meter is starting to tick again.

And finally, the dollar’s softening in sympathy—a sign that global capital is beginning to walk back from U.S. assets altogether, not just bonds. That makes the bond selloff feel even heavier, with cross-asset correlations starting to align in the wrong direction.

This move in yields isn’t a celebration of growth—it’s a repricing of risk, driven by sticky inflation, policy inertia, fiscal uncertainty, and positioning stress. Until one of those pillars breaks, yields may still have room to run—and not for reasons bond bulls want to hear.

Stock markets have experienced some turbulence in the bond market. Stocks may stabilize here, but the risk-reward dynamic has shifted without a clear fundamental catalyst. The debt ceiling X-Date, persistent inflation, funding concerns, and yield stress all contribute to a larger picture: the U.S. sovereign risk premium has returned to the forefront, and markets are beginning to account for it. Ink hasn’t met paper on tariffs, fiscal policy remains uncertain, and Wall Street’s Teflon streak just received a reality check that wasn’t, and likely isn’t, on many traders’ radar, although it soon will be.