The Basis Trade

The increasing reliance of the U.S. Treasury market on the highly leveraged basis trades of hedge funds as a source of liquidity poses a potential risk to market stability. Basis trade volume is now about double the level seen prior to the U.S. Treasury market dislocation of March 2020.

In our latest Strategic Insights, we examine how the Treasury basis trade works and outline what we believe are the most important implications for institutional investors.

The basis trade links three critical markets, U.S. Treasuries, Treasury futures, and repo financing, and relies on the use of leverage to capture small price differentials.

Our analysis examines:

• How asset managers’ use of Treasury futures creates the basis opportunity
• Why hedge funds employ leverage through the repo market
• The relationship between futures positioning and repo borrowing
• Historical episodes of basis trade unwinds
• Why the current size of the trade warrants attention

Download the full analysis in the latest Strategic Insights.