The bad news is, stocks are back-footed all of a sudden.

The good news is, bonds have recaptured the negative correlation magic, which is to say Treasurys are rallying hard, offsetting some of the pain for balanced portfolios.

“Way” back on October 3, I suggested we might’ve seen the local highs for yields, and that as such, a product like ZROZ (a de facto leveraged duration bet) could be poised for a tactical rally.

Fast forward three weeks and voilà: +11%. And counting.

Have a look at that. Measured on a rolling three-week basis, this is the best run for the STRIPS ETF since Janet Yellen’s late-2023 intervention-by-QRA, which rescued Treasurys from an unprecedented third consecutive annual decline.

Part of the rates rally’s obviously an extension of the short squeeze which kicked off last week on profit-taking in and around the above-consensus CPI-PPI series. But there’s a fundamental macro story here too.

As discussed in “Return Of The Left-Tail,” credit jitters in “subprime AI” are raising questions about the sustainability of the leveraged buildout that’s propping up growth and driving blockbuster earnings, both realized and expected, for AI enablers. I wouldn’t call it “growth scare” just yet, but the zeitgeist is shifting and bonds are picking it up.

The figure above shows you what happens when a simple short monetization exercise snowballs into an outright squeeze.

10s were back trading with a four-handle on Thursday amid what counted as the single biggest one-day rally for benchmark US debt since the late-July/early-August 2024 growth scare / yen carry unwind panic.

Souring AI sentiment’s “contributing to a feedback loop where suddenly, we’re witness[ing] USTs ‘working’ again as risk asset hedges into this micro cluster of thematic AI equities vol expansion,” Nomura’s Charlie McElligott said. “Again: Those prior assumptions of ‘forever capex’ are no longer what they once were,” he added, referencing the notion that if funding costs put the brakes on the AI buildout, the “trickle down” effect from data center spending will be commensurately attenuated.

The figure above shows you Meta’s CDS (with Oracle’s, for context). Default protection on ol’ Zuck didn’t even trade prior to the company’s $30 billion bond sale this time last year. Now it’s ~120bps.

Coming full circle, the silver lining is that bonds are performing as they “should.” As McElligott put it, “Treasurys are — gasp — working as your hedge again, as the market seems to be real-time repricing the probabilities of a US growth scare off the back of the AI reset.”

Writing earlier Thursday, BMO’s Ian Lyngen summed it up. “The health of corporate credit markets has been in focus [as] tech bonds come under pressure and the rise in credit default swaps on AI-related issuers has been weighing on risk sentiment,” he wrote. “US Treasurys have emerged as a primary beneficiary as global risk sentiment has come under pressure.”