Hedge funds are re-engaging with the popular swap spread widener trade, which bets that Treasuries will outperform swaps of the same maturity, as the gap between US Treasury yields and interest-rate swap rates continues to expand, according to a report by Bloomberg.
The strategy has regained momentum after early-week volatility briefly threatened the trend. Bond yields had jumped following a sell-off in Japanese government bonds and heightened geopolitical tensions between the US and Europe over Greenland. However, sentiment stabilised after US President Donald Trump said a framework agreement on the Arctic territory had been reached.
By Friday, the 30-year US swap spread widened to around 62 basis points inverted, its widest level since December 2022, rising roughly 8 basis points over the week.
The trade has grown increasingly popular in recent months, supported by expectations that US deregulation will free up bank balance-sheet capacity, favouring demand for Treasuries. Spreads also moved wider following comments from Federal Reserve Governor Stephen Miran, who said sweeping deregulation could support easier monetary policy.
According to a December report from the Bank for International Settlements, the cash component of the swap spread trade had grown to around $631bn, more than double its size in early 2024, and has become a major driver of hedge fund exposure to US government bonds. While substantial, it remains smaller than the cash–futures basis trade, estimated by Morgan Stanley at close to $1.5tn.
Wall Street strategists say several policy developments are reinforcing the trade. Trump administration efforts to lower housing costs — including directing Fannie Mae and Freddie Mac to purchase $200 billion of mortgage-backed securities — are expected to generate hedging flows in swaps. Meanwhile, Federal Reserve purchases of Treasury bills aimed at easing repo market conditions are also seen as supportive of the long-cash leg of the strategy.
Major banks have positioned accordingly. Barclays favours long positions in five-year swap spreads due to expected mortgage hedging flows, while Morgan Stanley holds two-year spread longs, citing ample liquidity in funding markets. TD Securities has also forecast wider swap spreads this year as funding conditions improve and regulatory changes unlock dealer balance-sheet capacity.
Despite the renewed momentum, risks remain. The trade suffered a sharp unwind in April when tariff-related market turmoil triggered margin calls, highlighting its vulnerability to sudden volatility. Analysts also warn that increased Treasury supply and a wave of corporate issuance — including debt linked to artificial intelligence investment — could push yields higher and limit further widening.
