Big bets by hedge funds against Treasury securities pose a risk to the global financial system, the Bank of England has warned.
In its latest financial stability report, published Wednesday, the U.K. central bank noted that short positions in Treasury futures have increased notably of late and are now at levels not seen since 2018.
The BoE said its “market intelligence” suggests these futures positions are not outright bets that government bond prices will fall and yields rise, but trades relative to bonds or swaps.
These so-called “basis trades” look to exploit small price differences between economically similar cash bonds and Treasury futures. To make notable returns the trades are highly leveraged and require low volatility.
Source: Bank of England
The trade blew up the bond market in early 2020 when the COVID pandemic caused a surge in Treasury volatility amid a surge in demand for government debt.
But vulnerabilities remain in the system of market-based finance, said the BoE.
“For instance, over recent months, leveraged hedge funds have built up large positions in U.S. Treasury futures, which market intelligence suggests are relative to bonds or swaps. If these markets were to move sharply, deleveraging these positions could further amplify stress,” it said.
The BoE added: “These risks, and other underlying vulnerabilities in the system of MBF…remain largely unaddressed and could resurface rapidly. In particular, the sharp transition to higher interest rates and currently high volatility increases the likelihood that MBF vulnerabilities crystallise and pose risks to financial stability.”
The ICE BofAML MOVE index, which tracks Treasury price volatility, is currently trading around 122, down from a 14-year peak around 180 seen at the start of the year. In that time the yield on the 10-year U.S. Treasury
TMUBMUSD10Y,
has moved within a range of roughly 3.30% to just over 4%.
This story originally appeared on Marketwatch
