About a fifth of the money in the Treasury basis trade has left this year, leaving roughly $1.2 trillion. Most of the exit has come in two-year and five-year futures, where asset managers have cut their own positions.
Regulators have spent years worrying that a leveraged hedge fund strategy could turn a Treasury selloff into a crisis. As this year's selloff has deepened, that strategy has been getting smaller.
Morgan Stanley puts the money tied up in the Treasury basis trade at roughly $1.2 trillion, a fifth less than at the start of the year. The trade pairs a purchase of cash Treasury securities with a sale of the matching futures contract, and profits from the narrow price gap between them. Because that gap is small, funds borrow heavily to make the returns worthwhile. That borrowing is what has drawn scrutiny, since margin calls in past market shocks forced funds to sell quickly.
Most of the shrinkage has come in two-year and five-year futures, the bank found. Weekly positioning reports from the Commodity Futures Trading Commission tell the same story. In two-year contracts, the net short held by hedge funds is now more than 40% smaller than its March peak, the highest in 15 months, and less than half its December 2024 record. The net long held by asset managers on the other side has shrunk more than 30% from its own March record.
That second figure explains much of the first. The basis trade relies on fund managers, mutual funds among them, who buy futures to lengthen the duration of their portfolios. Hedge funds supply those futures and hedge by holding the underlying bonds. When asset managers want fewer futures, hedge funds have fewer to sell.
"The basis position in the market has been declining because the opportunity set is lower," said Meghan Swiber, a U.S. rates strategist at Bank of America. "The other part of this is that asset manager demand for Treasury futures has also been moderating."
When fund managers want fewer long positions, hedge funds have a harder time putting the trade on, said Eli Carter, a fixed income strategist at Morgan Stanley, and that is most true in shorter maturities. Two-year and five-year notes react most sharply when traders raise their bets on Fed hikes.
Two policy changes have also narrowed the opportunity. Late last year regulators eased the supplementary leverage ratio, freeing big banks' dealer desks to carry more Treasuries. Price dislocations that basis traders once exploited now get absorbed by dealers. Amrut Nashikkar, who runs interest rate derivatives strategy at Barclays, described the effect: "When dealers' ability to hold Treasury inventory increases, and it has, what that naturally does is that it reduces the relative value opportunity for the basis trade." Separately, Treasury buybacks have lifted the prices of older, off-the-run bonds, cutting into another source of gains.
None of this means the trade has disappeared. "While returns have become less attractive and notional has declined, we think the trade remains alive and well," Morgan Stanley analysts wrote. The firm has seen no sign of wider strain linked to basis positions, even with higher yields and more bank dealers in the market.
A $1.2 trillion position is still large enough to matter in a disorderly market. With the retreat focused on short maturities, a larger share of what remains may sit further out the curve, in 10-year and long-bond futures, where the trade also has significant activity. The next CFTC positioning reports will show whether funds are trimming there as well, or holding on.