The Bank of England has identified a leveraged trade in US Treasury futures that has regained popularity with hedge funds, as one of the bigger risks to global financial stability, according to a report by The Financial Times.
The Bank of England (BoE) has identified a leveraged trade in US Treasury futures that has regained popularity with hedge funds, as one of the bigger risks to global financial stability, according to a report by The Financial Times.
The so-called basis trade typically involves exploiting small price differences, often because of different regulatory treatment, between economically identical cash bonds and futures. With price differences marginal, hedge funds look to boost returns by borrowing money in the repo market, and while the strategy tends to work well in a low-volatility environment, it can backfire if the market moves quickly.
At the start of the coronavirus pandemic in 2020 of instance, a rush by investors to unwind leveraged basis trades caused liquidity to dry up in Treasuries and other money markets.
Such risks “remain largely unaddressed and could resurface rapidly,” the BOE said in its latest financial stability report. “In particular, the sharp transition to higher interest rates and currently high volatility increases the likelihood that market-based finance vulnerabilities crystallise and pose risks to financial stability.”
