From MarketWatch, April 17:
Worries about the potential risks of the ‘basis trade’ are mounting
Investors now have one more reason to be worried about the world’s largest debt market.
Hedge funds’ share of the $31 trillion U.S. Treasury market recently climbed to a record 8%, Apollo Global Management Chief Economist Torsten Slok wrote in a Friday note, detailing the trend in the chart below.
Photo: Apollo
That growing footprint is drawing scrutiny because hedge funds often finance their Treasury trades with borrowed money, including in a strategy sometimes referred to as the “basis trade” — meaning their expanding role can amplify stress when markets turn volatile. As a result, any abrupt pullback in these heavily leveraged positions “could send shockwaves through global fixed-income markets,” Slok said. More than $6 trillion in repo and prime-brokerage funding sits behind those positions, he noted.
Federal Reserve economists have even said that the official numbers may underestimate the size of hedge funds’ role in the Treasury market.
Investors care because the Treasury market sits at the center of the global financial system. As the foundation for borrowing costs, any disruption in Treasurys can quickly reverberate through stocks, corporate bonds, mortgages and funding markets.
Those concerns came on top of longer-term worries about the U.S. fiscal outlook....
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