Hedge Funds as the New Marginal Buyer of U.S. Treasuries

 

The Basis Trade: The Engine Behind Hedge Fund Demand

The reason hedge funds hold such large volumes of Treasuries is the “basis trade,” a relative‑value strategy that exploits the pricing gap between Treasury futures and the underlying cash bonds. In simple terms, the basis is the difference between the futures price of a Treasury contract and the spot price of the cheapest‑to‑deliver bond, adjusted for the cost of carry (such as financing and dividends).

A hedge fund engaging in the basis trade will typically:

• Buy the underlying cash Treasury bond (often longer‑dated notes or bonds).
• Short the corresponding Treasury futures contract.
• Finance the cash bond position via the Treasury repo market, borrowing cash against the bonds as collateral.

The profit arises when the futures price and the cash price converge by the delivery date, and the spread (the basis) compresses. If the futures price starts relatively cheap versus the cash bond, the trader expects to profit as the two prices move toward parity. The repo financing keeps the position levered, magnifying the economics but also the risk.

The key takeaway is that hedge funds are not participating as traditional investors in Treasuries. Because the basis trade is driven by relative‑value opportunities and not by duration or credit views, hedge funds are effectively acting as market makers, not as long‑term holders of government debt.

 

The Fed’s October 2025 Note: Cayman Hedge Funds Dominate Treasuries

A recent paper from the Federal Reserve covered this trend.  In an October 2025 research note titled “The Cross‑Border Trail of the Treasury Basis Trade,”[1] the authors drew on regulatory filings (Form PF), Treasury International Capital (TIC) data, and repo‑market statistics to show that hedge funds domiciled in the Cayman Islands now hold more U.S. Treasury notes and bonds than any other single investor group.

The Fed’s note highlights several data points to demonstrate the surprising size of hedge fund participation in Treasury markets:

• Regulatory filings estimate that Cayman‑based hedge funds held about $1.85 trillion of U.S. Treasuries at the end of 2024, roughly $1.4 trillion higher than the amount shown in official TIC data for the Cayman Islands.
• Between 2022 and 2024, these funds absorbed around 37% of net issuance of longer‑dated Treasury notes and bonds, roughly equivalent to the combined purchases of all other foreign investors.
• The discrepancy between the TIC data and the regulatory data suggests that cross‑border repo financing and basis‑trade activity are being significantly under-captured in traditional Treasury holder statistics.

In essence, the Fed’s note argues that Cayman‑domiciled hedge funds have become the “marginal foreign buyer” of U.S. Treasuries, a role that historically was filled by central banks, sovereign‑wealth funds, or foreign institutional investors.

[1] The Fed - The Cross-Border Trail of the Treasury Basis Trade

 

Regulatory and Market Implications

This dominance of hedge funds in the Treasury market has several important ramifications, spanning liquidity, regulation, and broader market structure.

1. SEC’s Concern Over Liquidity Risk and the 2027 Mandate

The SEC has long viewed the basis trade as a potential source of liquidity risk, because hedge funds are levered, fast‑moving players rather than long‑term “core” holders. The risk materialized in March 2020, when the COVID‑19 shock triggered a rapid unwind of basis‑like positions and a sharp repricing of Treasuries. As dealers and hedge funds tried to reduce leverage and de‑risk, the normally deep repo and cash markets became extremely strained, with spikes in repo rates and wide bid‑ask spreads.

In response, the SEC has moved to impose a central clearing mandate for U.S. Treasury transactions. The rule, finalized in 2024, requires eligible cash and repo trades in U.S. Treasuries to be cleared through a central counterparty (CCP). The phased rollout sets:

• December 31, 2026 for eligible cash‑market transactions; and 
•  June 30, 2027 for eligible Treasury repo transactions.

By centralizing these trades, regulators aim to reduce bilateral counterparty risk, improve transparency, and mitigate the risk of a sudden, disorderly unwind like the one seen in March 2020.

2. Repo Market Liquidity Boosted by the Basis Trade

The Treasury repo market has benefited from the growth of the basis trade, as hedge funds increasingly tap repo financing to fund their long‑side Treasury positions. Repo transactions collateralized by Treasuries have become larger and more active, with more participants willing to lend cash against high‑quality collateral.

This has supported tighter repo spreads and improved intraday liquidity, reinforcing Treasuries’ role as the global risk‑free collateral of choice. However, the concentration of repo financing activity among a relatively small group of offshore hedge funds also makes the system more sensitive to changes in their funding behavior.

3. Central Clearing Liquidity: FICC and the Growth Curve

As the SEC’s clearing mandate approaches, the volume of Treasuries cleared through entities such as the Fixed Income Clearing Corporation (FICC) is expected to rise sharply. FICC’s Government Securities Division (GSD) already serves as a major clearing utility for U.S. Treasury cash and repo transactions, and regulators have designated FICC and CME Securities Clearing Inc. (CMESC) as key CCPs for this market.

Preliminary data from the Fed and market practitioners show that average daily cleared volumes have expanded significantly:

• From average transactional volumes of roughly $4.5 billion per day in 2022 to over $9 billion in 2025, reflecting both organic growth in repo activity and early migration toward cleared infrastructure.

This trend is likely to accelerate after 2026, as bilateral repo trades are increasingly routed through central clearing ahead of the central clearing mandate.  Central clearing, led by FICC, is evolving in a more transparent barometer of Treasury‑market liquidity.

4. The Paradox: Non‑Core Players as Rate‑Setters

There is a striking paradox at the heart of this story. Hedge funds are not “core” participants in the traditional sense. They do not have a policy mandate to hold Treasuries indefinitely, nor do they act as market‑makers in the way primary dealers do. Instead, they are pursuing a relative‑value strategy, seeking to squeeze out small but consistent returns from the basis between futures and cash bonds.

Yet because of the sheer size of their positions, hedge funds have become key participants in Treasury markets and instrumental in keeping U.S. interest rates from rising higher, especially at a time of massive fiscal deficits. Their demand for Treasuries effectively absorbs a substantial portion of supply, reducing upward pressure on yields.

This dynamic creates a policy tension: 

• On one side, the U.S. Treasury depends on hedge‑fund buying to finance deficits without triggering a disorderly rise in rates.
• On the other, the SEC and other regulators must ensure that markets remain orderly and that liquidity does not evaporate if the basis trade suddenly unwinds.

Such tension also further reaffirms that the deadlines for the central clearing mandate will not likely be extended again.

 

Conclusion: A Quiet But Critical Market Shift

Hedge funds are now quietly the single largest participant in the U.S. Treasury market, but critically also operate uniquely from other size holders. Their dominance, driven largely by the basis trade and supported by the repo market, is only partially visible in traditional Treasury holder statistics.

The U.S. Treasury needs these players to keep buying, but regulators need to guard against the liquidity risks that come with highly levered, fast‑moving positions. The result is the SEC’s central clearing mandate, which will push many of today’s bilateral repo trades into cleared venues such as FICC.

As hedge funds move more of their repo activity onto central clearing platforms, the volume and transparency of Treasury‑backed repo liquidity are poised to increase substantially over the next several years. For institutional investors, this shift underscores a simple but crucial point: to understand where U.S. rates are going, you must first understand the hedge funds behind them.