Hedge Fund Treasury Basis Trade Shrinks to Two-Year Low of $900 Billion, Morgan Stanley Estimates

Hedge funds' favored Treasury basis trade has contracted sharply, with Morgan Stanley estimating the notional size of leveraged investors' positions fell to about $900 billion from $1.26 trillion at the start of 2026 — the lowest in more than two years — as narrowing spreads between Treasury futures and cash bonds erode arbitrage gains. The basis trade involves hedge funds borrowing heavily to buy cash Treasuries while selling corresponding futures, betting the spread converges. Its growth has supplied liquidity to the $32 trillion Treasury market, so the pullback had raised concerns about a key source of demand retreating. Morgan Stanley and Citi strategists said the trade is far from dead and see no evidence of Treasury market stress, attributing the decline to fewer relative-value opportunities rather than forced unwinding. The contraction is concentrated in two- and five-year notes, while long-end positions linked to 25- to 30-year bonds have increased, according to Morgan Stanley's Eli P. Carter. CFTC data show asset managers cut net long positions in short-dated Treasury futures this year. Citi's Jason Williams said falling spreads and volatility reflect stronger real demand for Treasuries. Treasury buybacks, the Fed's halt to quantitative tightening and greater bank holdings have also reduced pricing dislocations.