The $29-trillion Treasury market had surged in recent weeks as investors dumped stocks for the safety of government bonds in a tariff-fueled risk-off shift. But on Monday, even as equities stayed under pressure, Treasuries were hit by a wave of selling that sent benchmark yields soaring by 17 basis points on the day, while trading within a yield range of about 35 basis points, one of the wildest trading swings for 10-year yields in two decades.
The selloff picked up pace on Tuesday and into Wednesday, pushing benchmark 10-year yields above 4.425%, 16 basis points higher on the day.
Some market participants said they believed based on the dramatic Treasury market moves and sharp tightening of swap spreads that investors including hedge funds have been selling liquid assets such as U.S. government bonds to meet margin calls due to portfolio losses across asset classes. Some hedge funds have offloaded stocks as the market plunge forces them to curtail trading using borrowed cash.
"The big moves in the market across asset classes triggered the unwind," said Jan Nevruzi, U.S. rates strategist at TD Securities in New York.
Investors and analysts said the move was reminiscent of the dash-for-cash at the onset of the COVID-19 pandemic in March 2020, when the market seized up as fears about the coronavirus grew, prompting the U.S. central bank to buy $1.6 trillion of government bonds.
Similar to that episode, at play on Monday was also a reduction of the so-called basis trade, a popular hedge fund arbitrage trading strategy between cash and futures Treasury positions whose unwinding likely exacerbated the 2020 crash, investors and analysts said.
"When you have big moves like that and you're relying on some arbitrage relationship, spreads tightening for whatever reason, you might have to trim your positions," Nevruzi said.
The basis trade has been closely watched by regulators over the past few years because it could be a source of instability for markets if highly leveraged hedge fund positions are unwound rapidly. That scenario could reduce banks' ability to provide liquidity, or intermediation, in the Treasury market, the building block of global finance.
Torsten Slok, chief economist at Apollo Global Management, estimated in a note on Tuesday the basis trade is currently worth around $800 billion.
Hedge funds typically borrow from the repo market to buy Treasuries and use the latter as collateral. Falling prices of Treasuries due to the selloff provided less collateral value for borrowing, prompting margin calls, analysts and investors said.
"There was certainly some unwinding of a lot of basis trades over the last few days, some margin calls to banks," said David Rolley, portfolio manager and co-head of the Global Fixed Income Team at Loomis Sayles.
To be sure, other triggers could be at play. One explanation is the bond market is coming around to the view that U.S. President Donald Trump's tariffs on large U.S. trade partners are inflationary, which would curb the Federal Reserve's ability to cut interest rates despite slowing growth.
"Can you really bid bonds when we might have a 4% handle on inflation again two months from now?" said Spencer Hakimian, CEO of Tolou Capital Management.
'DEMAND DESTRUCTION'
Many in the markets remain worried the vulnerabilities that emerged in previous incidents, such as in March 2020, could still reappear in the case of spikes in volatility.
"We have been banging the tables for years that the depth of liquidity in the Treasury market is poor and has been for years," Andrew Brenner, head of international fixed income at National Alliance Capital Markets, said in a note to clients on Tuesday. "These basis trades, which can be leveraged up to 100x, overwhelmed the bond markets," he said in reference to Monday's sharp bond selloff.
Besides the sharp increase in yields, several analysts also pointed to changes in the price differential between Treasuries and interest rate swaps as evidence of specific selling of Treasuries, as opposed to a broader move reflecting, for instance, changes in monetary policy expectations.
An executive catering for hedge fund clients at a large bank, speaking on condition of anonymity, said investors have been looking for alternatives to U.S. assets amid market volatility, including alternatives to U.S. Treasuries.
Swap spreads, which reflect the gap between the fixed rate on an interest-rate swap and the yield on a comparable Treasury and are often used to hedge or bet on shifts in rates, tightened dramatically, particularly for longer-dated maturities.
The underperformance of Treasuries compared to swaps signaled "heavy foreign real money selling," said Jonathan Cohn, head of U.S. rates desk strategy at Nomura Securities International.
A consensus trade among hedge funds was to be positioned for a widening of swap spreads, he said, due to expectations of further bank deregulation. Those positions likely had to be unwound, contributing to the Treasury selloff, added Cohn.
The 10-year swap spread has dropped sharply or tightened since April 3, after Trump's announcement of sweeping tariffs on imports. They were last seen at minus 63 basis points - their most negative since at least late 2022.
Analysts at Citi said in a note on Tuesday the selloff culminated on Monday with a "light dash-for-cash, showing signs of possible demand destruction for U.S. Treasuries."
While factors driving swap spreads lower are generally a sign of worries over the fiscal trajectory, they said tariffs were also adding pressure.
"Presumably less trade will limit the growth in global USD reserves which tend to find their way into U.S. Treasuries," they said.
