The increased use of leveraged Treasury trades by hedge funds is now drawing the scrutiny of economists at the Federal Reserve Board in Washington.
Hedge funds’ increased use of leveraged trades in the $25.1 trillion Treasury market is now drawing scrutiny from economists at the Federal Reserve Board in Washington.
“Is the basis trade ‘back’? In short, the answer is ‘probably,’ at least to some degree,” they wrote in the paper posted to the Fed’s website. Data from the Commodities Futures and Trading Commission, along with the Treasury Department’s Office of Financial Research, are consistent with hedge funds increasing their positions in the basis trade, according to the economists.
Such a trade is seen as one of the biggest ways in which hedge funds have ramped up an overall bearish view on U.S. government debt — diverging from asset managers and individual investors in a way that’s led to a zigzagging 10-year yield BX:TMUBMUSD10Y in August. “This trade presents a financial stability vulnerability because the trade is generally highly leveraged and is exposed to both changes in futures margins and changes in repo spreads,” Barth, Kahn and Mann wrote. For example, “hedge funds unwinding the cash-futures basis trade likely contributed to the March 2020 Treasury market instability.”
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