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IMF highlights hedge fund risk to US Treasury market

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The IMF has warned that a “concentration of vulnerability has built up” which poses a potential risk to wider financial stability, given that a small group of hedge funds now accounts for the vast majority of short positions in the US Treasury futures market, according to a report by Bloomberg.

The report quotes the IMF’s Global Financial Stability Report, released this week: “Some of these funds may have become systemically important to the Treasury and repo markets, and stresses they face could affect the broader financial system.”

Leveraged hedge funds have ramped up their leveraged short positions in US Treasury futures in a bid to capitalise on the basis trade, which involves exploiting the tiny price discrepancies between cash Treasuries and their underlying futures counterparts.

According to the IMF report, as of December, about half the two-year Treasury short positions in the futures market were in the hands of just eight traders or less. While the report doesn’t cite specific funds, in December, another Bloomberg report revealed that firms including ExodusPoint Capital Management, Millennium Management and Citadel have all used the wager.

The IMF acknowledges that basis trades are helpful in providing market liquidity but has expressed concerns about the risk from current concentrated positions, given that funds have become so crucial to the Treasury and repo markets that they are now essentially too big to fail.

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