A popular that exacerbated a crash in the world’s biggest bond market in 2020 has retuned
Researchers at the Federal Reserve have issued warnings in recent weeks about possible disruptions in U.S. Treasuries due to the return of a popular hedge fund trading strategy that exacerbated a crash in the world’s biggest bond market in 2020.
In two separate notes in recent weeks, economists at the Fed have highlighted potential financial vulnerability risks related to these trades, which are taking place at a time of volatility in the U.S. government bond market due to higher interest rates and uncertainty over future monetary policy actions.
This would exacerbate episodes of market stress, they warned, “potentially contributing to increased Treasury market volatility and amplifying dislocations in the Treasury, futures, and repo markets.” Should financing costs increase in the repo market - where hedge funds obtain short-term loans against Treasury and other securities - the spread, or premium, of futures contracts over underlying cash Treasuries would also need to increase to maintain basis trade positions profitable.
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