Hedge funds hold $2 trillion in US debt, but their next trade could require fewer bonds

Much of hedge funds' Treasury buying is tied to trades designed to earn small differences between bond and derivatives prices, making them important customers for Washington but not the type of investors who hold government debt for decades. According to Dallas Federal Reserve research published Oct. 16, alternatives to the cash-futures basis trade have become more attractive, allowing funds to achieve similar results with significantly less Treasury debt.

This shift means the government may need other investors to purchase securities that hedge funds no longer want to finance, potentially at higher yields. The research highlights a different problem from the familiar narrative of leveraged investors dumping bonds during crises, focusing instead on managers reallocating risk capital to more efficient strategies.

The cash-futures basis trade

Asset managers seeking exposure to government bonds can purchase them directly or use Treasury futures to obtain similar interest-rate exposure without holding the actual securities. When futures become expensive relative to the bonds they represent, hedge funds buy the cheaper securities, sell futures, and attempt to profit from the price difference.

Funds typically finance these cash bonds through repo arrangements, which resemble collateralized loans. Using the Federal Reserve's data, the estimated cash-futures basis position grew from $213 billion in January 2023 to $832 billion in September 2025, while the swap-spread position increased from $42 billion to $305 billion during the same period.

Alternative strategies require less debt

The Dallas Fed identified a competing strategy that pairs Treasury purchases with interest-rate swaps, where funds pay fixed rates and receive floating ones. This swap-spread widener has become comparable in risk-adjusted returns to the classic basis trade but requires less debt for the same risk exposure.

This means investors can maintain similar trading strategies while borrowing less against Treasuries and reducing cash demand in the government-bond market. The original basis trade has also become less appealing to some investors as higher yields have made eligible bonds more similar for certain long-maturity contracts, reducing the value of delivery flexibility.

Market implications

If hedge funds gradually reduce their Treasury holdings, pension funds, overseas buyers, banks, and households could purchase these securities instead, provided the yields offer sufficient returns. Bond prices and yields move inversely, so a market needing more patient buyers might reach them through slightly cheaper bonds and higher yields rather than disorderly liquidation.

Stablecoin issuers like Tether and Circle also buy government securities to back dollar tokens, but their demand is concentrated in short-term Treasury bills and can't automatically replace demand for longer maturities. The IMF notes that hedge funds, which improve trading liquidity in normal conditions, can amplify price moves when crowded positions must be reduced simultaneously.

Historical comparisons show this shift is less alarming than past crises. During the April 2025 tariff announcements, the Fed's estimated swap-spread exposure dropped 20% while basis exposure increased. By September 2025, the basis estimate had recovered to $832 billion, below its June peak of $894 billion.