Hedge funds sour on basis trade as Treasury selloff continues

Funds’ leveraged Treasury basis-trade holdings have fallen 20% this year to an estimated $1.2 trillion, Morgan Stanley says. The trade uses overnight borrowing to profit from a narrow price difference between Treasury securities and futures. Lower trading opportunities and moderating asset-manager demand for Treasury futures have weighed on positions, Bank of America strategist Meghan Swiber said.

The pullback has been mostly concentrated in futures tied to 2-year and 5-year maturities, Morgan Stanley analysts said. Hedge funds’ net short positions in 2-year Treasury futures have fallen more than 40% from a 15-month high in March and more than half from a record in December 2024; asset managers’ net long positions are down more than 30% from a March peak.

Experts and portfolio managers said hedge funds still hold a large basis-trade position. Morgan Stanley said the trade remains active despite less attractive returns and lower notional exposure, and that higher Treasury yields have not yet produced evidence of broad market stress tied to the trade. Changes to supplementary leverage ratio requirements have allowed large banks to hold more Treasury inventory, which Barclays strategist Amrut Nashikkar said reduces the relative-value opportunity for basis traders.