Convexity Hedging Reawakens in Treasuries as $2 Trillion High-Coupon MBS Amplify Volatility

Convexity hedging, a mechanism that historically amplified bond market swings, is re-emerging in U.S. Treasuries, driven by a surge in high-coupon mortgage-backed securities. Goldman Sachs estimates MBS investors may need to sell the equivalent of $40 billion in 10-year Treasury futures or notes to rebalance hedges after yields climbed in May 2026 toward 19-year highs. The force, dormant since the Federal Reserve’s aggressive rate hikes crushed low-coupon MBS prices in 2022, is reviving as over $2 trillion in MBS with coupons above 5% now trade near face value — a level where convexity sensitivity peaks, Barclays notes. When rates rise, longer MBS durations force investors to sell Treasuries, intensifying selloffs. Conversely, falling rates trigger rushed buying. The Fed’s retreat from MBS purchases, with its portfolio shrinking from a $2.7 trillion pandemic-era peak, leaves hedge funds and private buyers aggressively hedging rate risk, making markets more reactive. MOVE Index creator Harley Bassman warned in a report that this “convexity beast” is waking, threatening to supercharge volatility if key yield levels break.