Despite repeated warnings from regulators and global watchdogs, the $1tn Treasury basis trade – a highly leveraged arbitrage strategy popular among hedge funds – continues to expand with little sign of systemic risk, according to a report by Reuters.
Positioning in US Treasury futures has climbed in recent weeks, with open interest across two-, five-, and ten-year contracts nearing record highs. This is the heart of the basis trade, where hedge funds take advantage of small price discrepancies between Treasury futures and the underlying cash bonds—often leveraging these trades up to 100 times via the repo market.
While past concerns have centred on the risk of a sudden unwind triggering financial instability, recent market behaviour suggests a more resilient structure. Treasury market volatility, as measured by the MOVE index, has declined sharply from early-April spikes, and repo funding conditions have stabilised after brief turbulence following last month’s tariffs introduced by the Trump administration.
“Leveraged funds are rebuilding basis positions at a pace that shows growing confidence in repo and cash bond markets,” said Deutsche Bank’s Steven Zeng. Data from the New York Fed further underscores this view, with SOFR-based overnight borrowing hitting a record $2.8tn at the end of April—clear evidence of robust liquidity and ample funding capacity.
For now, both sides of the trade remain committed: hedge funds continue peeling off incremental gains, while asset managers use futures markets to hedge and lock in yields ranging from 3.8% to 4.2%.
Still, risks remain. The term premium on long-dated Treasuries has reached a decade high, reflecting greater investor caution. A sharp spike in rates or unexpected policy shift could expose vulnerabilities in the highly levered positions. However, market participants widely believe the Fed or Treasury would intervene to stabilise any significant dislocation.
