Hedge Funds Cut Basis Trading Positions by $200B as Price Spreads Narrow

According to Morgan Stanley, leveraged investors have reduced funding in U.S. Treasury basis trading by over $200 billion in recent months, with total capital currently standing at around $1 trillion. Basis trading, which exploits price differences between Treasury futures and spot bonds, has lost appeal as the spread between the two instruments has compressed, squeezing arbitrage opportunities.

Multiple factors are pressuring the strategy, including increased Treasury holdings by Wall Street banks, reduced Treasury futures demand from asset managers, the Federal Reserve's pause on balance sheet reduction, and the Treasury Department's shift toward shorter-dated securities. Additionally, banks hedging against falling bond prices by shorting Treasury futures creates a similar economic effect to basis trades, further narrowing the price differential.