By Frances Yue
Worries about the potential risks of the 'basis trade' are mounting
Treasury yields fell on Friday on investors' hopes that the Iran war will soon end.
Investors now have one more reason to be worried about the world's largest debt market.
Hedge funds' share of the $31 trillion U.S. Treasury market recently climbed to a record 8%, Apollo Global Management Chief Economist Torsten Slok wrote in a Friday note, detailing the trend in the chart below.
That growing footprint is drawing scrutiny because hedge funds often finance their Treasury trades with borrowed money, including in a strategy sometimes referred to as the &#34;basis trade&#34; - meaning their expanding role can amplify stress when markets turn volatile. As a result, any abrupt pullback in these heavily leveraged positions could send ripples through global bond markets, Slok said. More than $6 trillion in repo and prime-brokerage funding sits behind those positions, he noted.
Federal Reserve economists have even said that the official numbers may underestimate the size of hedge funds' role in the Treasury market.
Read: Official data dramatically underestimates hedge funds' involvement in the Treasury market, Fed paper finds
Investors care because the Treasury market sits at the center of the global financial system. As the foundation for borrowing costs, any disruption in Treasurys can quickly reverberate through stocks, corporate bonds, mortgages and funding markets.
Those concerns came on top of longer-term worries about the U.S. fiscal outlook. Former Treasury Secretary Henry Paulson on Thursday urged policymakers to prepare an emergency plan in case demand for Treasurys were to break down.
Read: Former Treasury Secretary Henry Paulson warns U.S. needs an emergency 'break-the-glass' plan if Treasury demand collapses
Yet the rise in hedge-fund participation may rather reflect the market backdrop of the past two years more than any imminent crisis, according to Molly Brooks, rates strategist at TD Securities. Elevated yields and heightened volatility have made Treasurys more attractive to fast-moving investors such as hedge funds, Brooks said in a call.
The bigger question may not be whether a forced unwind is around the corner, but who would step in if hedge funds decide Treasurys no longer offer enough opportunity, Brooks noted.
If volatility fades and the Fed cuts interest rates more than expected, yields may become less appealing, prompting hedge funds to pull back and leaving other buyers to absorb supply, she said.
The dynamic also reflects a broader shift in the Treasury market's structure, said William Merz, head of capital-markets research at U.S. Bank Asset Management Group.
Since the global financial crisis in 2008, tighter regulations have curtailed the ability of large banks and trading desks to use their balance sheets to absorb Treasury supply, pushing more of that role to hedge funds and other nonbank investors,
As a result, the market may be more prone to periodic pockets of volatility, Merz said - though he argued that the change has not fundamentally altered medium- to long-term Treasury pricing or signaled a broader breakdown in demand.
At the same time, the buyer base has continued to evolve. Merz noted that individuals and mutual funds have taken on a larger role in Treasury ownership over time. And despite periodic chatter around a &#34;sell America&#34; trade, he said, that view has not been meaningfully reflected in Treasury holdings data.
The 10-year Treasury yield BX:TMUBMUSD10Y fell 6.5 basis points to settle at 4.24% on Friday, according to Dow Jones Market Data.
Read: How the 'trade of the year' in the bond market became a nightmare for investors after Trump's tariffs
-Frances Yue
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(END) Dow Jones Newswires
04-17-26 1712ET

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Hedge funds' share of the U.S. Treasury market has reached a record 8%, raising concerns about potential risks associated with their leveraged positions, particularly the 'basis trade'. This could lead to significant disruptions in the global bond market if hedge funds pull back. While some analysts suggest this trend reflects market conditions rather than an imminent crisis, the evolving buyer base and tighter regulations since the 2008 financial crisis have made the market more susceptible to volatility. The 10-year Treasury yield recently fell to 4.24%.

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Hedge funds' record Treasury bets risk sending a 'shockwave' through the global bond market, Apollo says