Against the backdrop of a continuously expanding US government debt, hedge funds are entering the approximately $30 trillion US Treasury market on an unprecedented scale. Data from the US Office of Financial Research shows that by the end of 2025, hedge funds' cash holdings of Treasury bonds had reached $2 trillion, almost three times that of five years ago; the size of tradable Treasury bonds was $28.9 trillion, with hedge funds accounting for a record 7%. More recent data from the Federal Reserve shows that domestic hedge funds remained net buyers in the first half of 2026, with net purchases of $60.6 billion in the second quarter, up from $26.4 billion in the first quarter, totaling approximately $87 billion in the first half of the year. This shift fills the void left by the exit of traditional buyers, but also poses a new challenge to the stability of the world's largest bond market.

Traditional buyers retreat, hedge funds fill the gap

Pension funds were once major holders of long-term government bonds, their ultra-long investment horizons matching liabilities for decades to come. However, structural changes are altering this landscape. The OECD points out that the shift from defined benefit plans to defined contribution plans has reduced pension funds' interest in long-term government bonds. Simultaneously, institutional investors are investing more in higher-yielding, less liquid assets such as private credit. Mercer data shows that institutions injected nearly $300 billion into private credit facilities by 2025. Hedge funds operate on a completely different investment logic. AdvisorShares founder Noah Hamman points out that pension funds and insurance companies focus on liability matching and long-term holdings, while hedge funds prioritize short-term performance, high water levels, and outperforming benchmarks. They use relative value strategies, particularly Treasury bond basis trading, buying spot Treasury bonds while simultaneously selling corresponding futures to capture small price differences. Because these differences are typically small, funds rely on repurchase agreements to build highly leveraged positions, with leverage ratios reaching 20 times or even higher.

Potential Impacts of Leverage Concentration and Basis Trading

Regulators have repeatedly warned of the risks. The Federal Reserve, in its May Financial Stability Report, stated that hedge fund leverage remains near historical highs and is concentrated in large funds, with high-leverage strategies supporting large positions in Treasury bonds and other markets. "High leverage could lead to spillover effects if funds suddenly lose access to funding," the report warned. The Bank for International Settlements went further, warning that hedge funds, as key intermediaries in the government bond market, are creating "new vulnerabilities to financial stability," and their reliance on leverage and short-term repurchase financing could make core markets more vulnerable to sudden deleveraging shocks. Signs of pressure are already emerging. Morgan Stanley estimates that leveraged Treasury basis trading positions have fallen by about 20% this year to $1.2 trillion. This pullback does not necessarily mean that hedge funds are massively selling off Treasury bonds—Fed data shows they were still net buyers in the second quarter—but it highlights how leveraged positions can shift rapidly when market conditions change. Don Steinbrugge, founder and CEO of Agecroft Partners, pointed out that the biggest risk lies in basis trading, which offers thin profit margins but extremely high leverage. As seen in March 2020, when liquidity in the Treasury market deteriorates sharply, leveraged funds may be forced to liquidate positions rapidly, creating a vicious cycle of margin calls, forced selling, and further volatility. Recent market sensitivity has increased: the 10-year Treasury yield rose to its highest level since 2007, while the 30-year yield reached its highest point since 2002, further testing the resilience of these positions.

Balancing liquidity contribution with systemic risk

Not all voices are pessimistic. Ken Heinz, president of Hedge Fund Research, believes that hedge funds' willingness to trade rather than simply hold to maturity provides bilateral liquidity during both rises and falls, potentially stabilizing interest rate fluctuations and reducing volatility. In normal market conditions, their activities help correct pricing discrepancies and improve market depth. Steinbrugge concludes that the growing role of hedge funds in the Treasury market is both a necessary source of liquidity and a potential source of systemic risk. Regulators should consider the potential risks of disorderly liquidation when formulating policies, while weighing the market liquidity benefits they provide. The current Treasury market is at a crossroads of profound changes in its buyer structure. The large-scale participation of hedge funds has alleviated government financing pressures but has also introduced higher leverage and shorter investment horizons into this core market. If volatility intensifies in the future, forced deleveraging could amplify the shock; if the market remains stable, they may become an important stabilizing force. The key lies in the controllability of leverage levels and the ability to cope with stress scenarios.

Editor's Summary

Hedge funds have risen to a record high share of the US Treasury market, filling the demand gap left by the retreat of traditional long-term buyers such as pension funds, and are expected to remain net buyers in the first half of 2026. Their relative value strategies, particularly basis trading, rely heavily on leverage and repurchase agreements, which can improve liquidity and pricing efficiency in normal times, but may trigger forced liquidations and liquidity spirals under extreme volatility. Regulators have clearly highlighted the risks of concentration and spillover effects, and market participants need to continuously weigh liquidity gains against systemic vulnerability.

Frequently Asked Questions

Q: Why have hedge funds quickly become major buyers in the US Treasury market? A: Traditional pension funds have seen a decline in interest in long-term Treasury bonds due to the shift in plan structure from defined benefits to defined contributions and increased allocation to private credit. Hedge funds have filled this gap by capturing price spreads through highly leveraged basis trading, becoming key net buyers in debt expansion. Q: How exactly does basis trading work, and what are the risks? A: Funds buy spot Treasury bonds while simultaneously selling corresponding futures, earning a small price difference. Because the spread is small, leverage of 20 times or more is often used, and positions are amplified through repurchase agreements. Increased volatility can force rapid liquidation due to rising margin requirements, triggering a chain reaction of selling pressure. Q: How high is the current leverage level, and how do regulators view it? A: The Federal Reserve has pointed out that leverage is near historical highs and concentrated in large funds. The Bank for International Settlements has warned that its reliance on short-term financing creates new vulnerabilities. High leverage can easily have spillover effects when financing channels tighten. Q: Does hedge funds' position pullback mean they are selling US Treasuries? A: Morgan Stanley estimates that basis trading positions declined by about 20% to $1.2 trillion, but Federal Reserve data shows that there were still net purchases of about $87 billion in the first half of the year. The pullback reflects more of a strategy adjustment than a complete exit. Q: Is hedge fund participation ultimately beneficial or detrimental? A: Under normal circumstances, it can provide bilateral liquidity and correct pricing discrepancies; during periods of stress, high leverage can amplify volatility. Its role combines the need for a source of necessary liquidity with potential systemic risk, requiring a balance between regulation and the market.