Fed economists sound alarm on hedge funds gaming US Treasuries
By Davide Barbuscia
NEW YORK (Reuters) — Researchers at the Federal Reserve have issued warnings in recent weeks about possible disruptions in U.S. Treasuries due to the return of a popular hedge fund trading strategy that exacerbated a crash in the world's biggest bond market in 2020.
Hedge funds' short positions in some Treasuries futures — contracts for the purchase and sale of bonds for future delivery — have recently hit record highs as part of so-called basis trades, which take advantage of the premium of futures contracts over the price of the underlying bonds, analysts have said.
The trades — typically the domain of macro hedge funds with relative value strategies — consist of selling a futures contract, buying Treasuries deliverable into that contract with repurchase agreement (repo) funding, and delivering them at contract expiry.
In two separate notes in recent weeks, economists at the Fed have highlighted potential financial vulnerability risks related to these trades, which are taking place at a time of volatility in the U.S. government bond market due to higher interest rates and uncertainty over future monetary policy actions.
«Cash-futures basis positions could again be exposed to stress during broader market corrections,» Fed economists said in an Aug. 30 note. «With these risks in mind, the trade warrants continued and diligent monitoring.»
Separately, in a Sept. 8 note that looked among other things at hedge funds' Treasury exposures, Fed economists said there was a risk of a rapid unwind of basis trade positions in case of higher repo funding costs.
This would exacerbate episodes of market stress, they warned, «potentially contributing to increased Treasury market volatility and amplifying
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