Fed: Basis Trade Drove Hedge Funds’ Surge in Treasuries

A Federal Reserve paper identifies the Treasury cash‑futures basis trade as the primary factor behind a large rise in hedge fund holdings of U.S. government debt. The Fed estimates basis positions at about $830 billion by September 2025 and says highly leveraged relative‑value strategies now make up nearly half of hedge funds’ $2.4 trillion in long Treasury positions.

The paper finds positions tied to the basis trade expanded rapidly after 2022 and reached roughly $830 billion by September 2025, about twice their previous pre‑pandemic peak. The Fed groups the basis trade with other leveraged relative‑value strategies, including swap spread arbitrage, when assessing hedge funds’ footprint in the Treasury market.

The cash‑futures basis trade typically involves buying physical Treasury securities financed through the overnight repo market while taking short positions in Treasury futures. Traders aim to capture small pricing differences between cash securities and futures contracts and use borrowed funding to increase returns.

The Fed’s analysis links the use of leverage in these strategies to the sharp growth in hedge fund long positions in Treasuries and to a large share of activity in the repo market. The paper notes that while basis trading can support liquidity and help align cash and futures prices, regulators have warned that heavy leverage could magnify losses and prompt rapid unwinds during periods of market stress.

Fed officials and other policymakers have expressed concern about the potential for a disorderly unwind of leveraged positions to affect other parts of the fixed‑income market. The paper emphasizes monitoring leverage, counterparty exposure in repo financing and the concentration of leveraged trades as indicators of possible vulnerability in Treasury markets.