Hedge funds hold a record share of the $30 trillion Treasury market. What could go wrong?

retained text

Hedge funds are becoming a force to be reckoned with in the roughly $30 trillion U.S. Treasury market, stepping in at a time when some traditional long-term investors have been looking at other options.
The shift is helping the government find buyers as its pile of debt grows, but it may also be making the world's largest bond market more vulnerable, experts told CNBC.
Hedge funds' cash Treasury holdings reached $2 trillion at the end of 2025, nearly three times their level five years earlier, the U.S. Treasurys Office of Financial Research said last month. Marketable Treasury debt — which is traded in the secondary market — was $28.9 trillion, putting hedge funds' share at a record 7%.
More recent Federal Reserve data shows hedge funds remained net buyers of Treasurys in the first half of 2026. Domestic hedge funds bought a net $60.6 billion in the second quarter, up from $26.4 billion in the first, bringing first-half purchases to about $87 billion.
The interest from hedge funds comes at a particularly sensitive time for the Treasury market, with the 10-year yield surging to its highest level since 2007 on Monday and the 30-year soaring to the highest since 2002 on Tuesday.
"Hedge funds apply relatively aggressive leverages as compared to other types of investors and therefore may magnify systematic risk," said Ricky Siao, a hedge fund specialist from Union Bancaire Privée.
"When forced deleveraging happens due to extreme situations or crisis scenarios, it may result in broader liquidity and financial stability event."
A different kind of buyer
Pension funds have traditionally been buyers of long-dated government bonds because the extended investment horizons allow them to match assets against liabilities stretching decades into the future.
But structural changes, including the migration from defined-benefit plans that promise a predetermined payout to defined-contribution plans whose value depends on investment returns, are reducing pension funds' interest in long-term government bonds, according to the OECD.
The shift also comes as some pension funds are increasing allocations to higher-yielding, less-liquid assets such as private credit. Institutional investors poured close to $300 billion into private credit vehicles in 2025, according to Mercer.
Regulators have also flagged risks that come with hedge funds' increasing participation. The Federal Reserve said in its May financial stability report that hedge-fund leverage remained near record highs and was concentrated among large funds, with leveraged strategies supporting significant positions in Treasurys and other markets. "High leverage can lead to spillovers if the fund suddenly loses access to funding," the Fed said.
The Bank for International Settlements went further, warning earlier this year that the rise of hedge funds as core intermediaries in government bond markets had created "new financial stability vulnerabilities." Their reliance on leverage and short-term repo financing could leave core markets more exposed to sudden deleveraging and bouts of market dysfunction, it said.
Hedge funds aren't simply buying Treasurys because they like the yield.
"They are very different, most pension and insurers have very long term time horizons and focus on liability matching. Hedge funds are about performance, typically shorter term focused on high watermarks and benchmark-beating returns," said Noah Hamman, founder of AdvisorShares.
Stress test
Much of hedge funds' activity involves relative-value strategies designed to exploit small pricing differences between closely related securities. One of the most prominent is the Treasury cash-futures basis trade, in which funds buy cash Treasurys while selling corresponding futures, expecting to gain from the price difference between the two markets.
Because the price differential between the cash and futures market is typically tiny, funds often use substantial leverage to generate attractive returns. Repo financing allows them to borrow against Treasury collateral and build positions many times larger than their underlying capital.
There are already signs that hedge funds are becoming more selective as the Treasury sell-off intensifies. Leveraged Treasury basis-trade position have reportedly fallen about 20% this year to $1.2 trillion, according to Morgan Stanley estimates.
The pullback doesn't necessarily mean hedge funds are dumping Treasurys outright, as Fed data shows they remained net buyers through the second quarter.
But the retreat underscores how quickly leveraged positions can shift when market conditions change and highlights the risk of a disorderly unwind during periods of stress.
"The biggest risk is the basis trade, where a hedge fund simultaneously buys Treasury notes and sells the futures contract that the notes are eligible to settle against," said Don Steinbrugge, founder and CEO of Agecroft Partners. "These trades have thin margins and can often be levered 20 times, if not higher."
"As we saw in March 2020, when Treasury market liquidity deteriorated sharply, leveraged funds can be forced to unwind positions quickly. This can create a vicious cycle of margin calls, forced selling, and further market volatility."
A spike in volatility can drive leveraged hedge funds to put up more cash or unwind their trades. That selling can push prices lower, deepen losses and force other funds to exit.
Besides raising concerns, experts also pointed to the constructive role of hedge fund in the Treasury market.
Ken Heinz, president of Hedge Fund Research, said that hedge funds' willingness to trade rather than simply hold bonds to maturity can provide two-sided liquidity during both rallies and sell-offs, adding that it could ultimately stabilize rate moves and reduce volatility.
The tension is therefore not that hedge funds are inherently bad for the Treasury market. In normal conditions, their trading can improve liquidity and help correct pricing discrepancies.
"Regulators should be concerned about the potential for a disorderly unwind while weighing the benefits of market liquidity that hedge funds provide when making policy decisions," said Steinbrugge. "Hedge funds' growing role in the Treasury market is both necessary for liquidity and a potential source of systemic risk."

document fetched 2026-09-30 03:01 · canonical https://cnbc.com/2026/09/30/us-treasury-market-is-relying-more-on-hedge-funds.html