From Bloomberg, April 9:
So-called basis trade seen as a cause for selloff
....All about that basis trade
An unnerving development is starting to unfold as Donald Trump’s trade war hammers financial markets: US Treasuries, far from offering shelter from the turmoil, are suddenly losing their haven appeal.
The plunge in bond prices brings back memories of the onset of the pandemic, says James Athey of Marlborough Investment Management, when widespread deleveraging sparked blowups of a popular hedge fund strategy known as the basis trade.
While there’s little concrete evidence of dealers cutting off financing or hedge funds getting caught wrong-footed thus far, Athey said he can’t shake the feeling that recent moves are just a taste of the hidden risk lurking beneath the market’s surface.
“It looked like in March 2020 when we got these wild moves, possibly relating to the basis trade,” he said. “Last week we had not seen any signs of hedge funds getting stopped out of the bond futures basis, but suddenly you’re seeing yields spike.”
The basis trade is a strategy hedge funds use to wager on the minuscule gaps between prices of cash Treasuries and futures. They typically borrow to multiply their bets, up to 50 or 100 times the capital invested. Recent estimates put the amount of existing wagers at about $1 trillion, roughly double what is was five years ago.
Problems can arise when market turmoil upends the economics of the trade and forces investors to rapidly unwind their positions to repay their loans. It can create a cascading effect that causes yields to surge, or even worse, the Treasury market to seize up, much like what occurred in 2020.
There are plenty of other reasons bonds might be selling off: The trade war will trigger stagflation that may prevent interest-rate cuts from the Federal Reserve. Foreign investors may be ditching US debt. Maybe fund managers are flocking to cash-like shorter-dated securities as risk assets swoon. And finally, portfolio managers may be selling to make room for a flood of new Treasury securities this week. —Liz Capo McCormick and Michael Mackenzie
....MUCH MORE (other topics)
If interested see also this from Bloomberg via Yahoo Finance, March 27:
Fed Urged to Explore Hedge Fund Bailout Tool for Basis Trade
