Concerns and Response to Basis Trade
In August, the Federal Reserve staff highlighted the need for careful surveillance of leveraged Treasury trades by hedge funds, citing their potential role in the market turbulence of March 2020. Strategists, such as Steven Zeng of Deutsche Bank, also expressed concerns about the ramifications of sudden unwinding of basis trades. Despite high U.S. interest rates, the basis trade remains popular. However, strategists suggest that forced selling by a specific firm could trigger a rapid unwinding scenario and that regulatory requirements may facilitate this.
Ben Emons, senior portfolio manager and head of fixed income at NewEdge Wealth, acknowledged the SEC and Fed’s close examination of the highly leveraged nature of these trades. Although he believes any rapid unwinding would likely have idiosyncratic elements, Emons attributes the potential impact to the SEC’s central-clearing requirement.
Differing Viewpoints
While concerns surrounding the basis trade persist, the Committee on Capital Markets Regulation, supported by the financial industry, argues that these concerns are overstated. They note that current trading activity is lower than previous peaks when measured relative to total Treasury debt outstanding.
Furthermore, Ken Griffin, the head of Citadel investment fund, suggests that regulators should concentrate on monitoring banks instead of hedge funds to safeguard the financial system against risks related to arbitrage trading of U.S. government bonds.
Amidst these discussions, Rostin Behnam, chairman of the Commodity Futures Trading Commission, downplays the media’s attention to the basis trade, stating that the size of the futures and cash market for Treasurys aligns with historical patterns.
The specific firms involved in basis trades are ExodusPoint Capital Management, Millennium Management, Capula Investment Management, and Symmetry Investments.