Hedge funds' $6 trillion leverage in treasurys signals new risk

Wall Street's primary dealers are returning to the US Treasury market at the fastest pace since 2007, but a more significant shift is happening in the shadows, where hedge funds have amassed an 8 percent market share using over $6 trillion in leverage.

"Once high-leverage positions are forced to be closed out collectively, it could send shockwaves through global fixed-income markets," Torsten Slok, chief economist at Apollo Global Management, said in a recent analysis.

The 10-year Treasury yield, a benchmark for global borrowing costs, has been trading in a historically narrow band between 4.0 percent and 4.6 percent, with a key volatility gauge at its lowest since 1991, according to a Reuters technical analysis. This surface calm masks the underlying leverage, with hedge funds now holding $2.4 trillion in long Treasury positions as of the end of 2025, nearly triple the level of three years ago.

This massive, leveraged position becomes critical as the US Treasury faces the need to roll over roughly $10 trillion of debt next year. A forced deleveraging, similar to the market seizure in March 2020 that required Federal Reserve intervention, could trigger a fire sale, causing a sharp spike in yields and a liquidity crisis that cascades into stocks and corporate credit.

Banks Return, But Hedge Funds Dominate

A primary driver for the increased presence of banks is the revision of the enhanced Supplementary Leverage Ratio (eSLR), which relaxed non-risk-adjusted capital requirements imposed after the 2008 financial crisis. This has allowed major institutions like Morgan Stanley and Bank of America to redeploy capital to Treasury trading, pushing primary dealer net holdings to an average of $550 billion, or nearly 2 percent of the market.

While a positive sign of market-making capacity, this is dwarfed by the role now played by non-bank actors. In the decade-plus since banks retreated from their traditional role, hedge funds have become the dominant force. Their share of the $31 trillion Treasury market has climbed to a peak of 8 percent, according to data from the New York Fed and Apollo.

The $6 Trillion Basis Trade

The expansion has been fueled almost entirely by the "basis trade," a strategy that seeks to profit from small differences between the price of a Treasury bond and its corresponding futures contract. Because the profits are minuscule, the strategy requires enormous leverage—provided by the repo market and prime brokers—to generate meaningful returns.

This concentration of risk is heavily obscured. After correcting for reporting gaps, Federal Reserve economists estimate that hedge funds registered in the Cayman Islands are now the single largest offshore holder of US Treasurys, with positions exceeding those of sovereign nations like China and Japan. Between 2022 and 2024, these funds absorbed 37 percent of all net issuance of medium- and long-term US debt.

A $10 Trillion Rollover on Unstable Ground

The structure's fragility will be tested by the Treasury's immense financing needs. With about one-third of all outstanding US debt maturing, the government must find buyers for approximately $10 trillion in new bonds next year.

This comes as traditional buyers are stepping back. Foreign central banks have been net sellers, collectively offloading more than $82 billion in Treasurys, bringing their holdings to the lowest point since 2012. The dynamic creates a precarious situation where the market's stability depends on the continued availability of cheap funding for massively leveraged trades. Former Treasury Secretary Henry Paulson recently urged policymakers to develop contingency plans for a scenario where demand for US debt collapses.

The last significant test of this structure in March 2020 saw the basis trade unravel, forcing the Federal Reserve to inject unprecedented liquidity to prevent a systemic collapse. With leverage now far higher, the potential for a similar, or even larger, disruption looms over a market that appears deceptively calm on the surface.

This article is for informational purposes only and does not constitute investment advice.