Surging Scale: Nominal scale approximately $1.5 trillion, expanding faster than treasury bond issuance
Morgan Stanley strategists in their latest report estimate that the nominal size of U.S. Treasury "basis trades" (arbitraging price differences between bonds and futures) has expanded to around $1.5 trillion. The bank states that this strategy has grown approximately 75% from its peak in 2019, expanding even faster than the issuance of U.S. Treasuries in recent years, thus needing closer monitoring.
Risk Mechanism: Once forced to close positions, market intermediaries might struggle to handle the trading surge
Basis trades are typically dominated by hedge funds, relying on the convergence of price differences for profit. However, Morgan Stanley warns that the real vulnerability lies in liquidity: if funding conditions tighten or market volatility rises, funds forced to rapidly reduce positions could overwhelm the bond dealers' capacity to absorb transactions, thus amplifying localized pressure into systemic shocks.
Increased Concentration: 5-Year Contracts Most "Crowded," Mid-Curve Risk Exposure Expands
Morgan Stanley points out that current risks are highly concentrated in 5-year Treasury futures, followed by ultra-long-term and 10-year contracts; meanwhile, risk exposure in the "mid-curve" of the yield curve is also expanding, suggesting that if adverse conditions occur, the impact may be more concentrated and swift.
Why It Reminds of 2020: When Spot Lagged Futures, Prompting Fed Intervention
The report mentions that in 2020, there was a situation where Treasury spot underperformed futures, contrary to the market conditions most relied upon by basis trades, leading to losses for hedge funds and playing a role in the intense volatility of the time; the Fed subsequently stabilized the market by purchasing large amounts of Treasuries and injecting liquidity into the repo and other short-term markets. Notably, Morgan Stanley notes that the scale of basis trades back then was about $500 billion, only about a third of the current scale.
Regulatory Scrutiny Heats Up: BIS and Bank of England Warn of Leverage and Crowded Trade Risks
On the risk notification front, an article from Investing.com states that global regulators have intensified their scrutiny of this strategy; the Bank of England and the Bank for International Settlements (BIS) have both issued warnings about the financial stability risks posed by highly leveraged "relative value" trades by a few large hedge funds.
