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Hedge Funds Are Taking Over the $25 Trillion U.S. Treasuries Market

Sept. 27, 2023, (EIRNS)—The $25 trillion market in U.S. Treasury bonds is the largest market of any kind in the world today, and it is the pace-setter for all financial instruments throughout the trans-Atlantic financial system. An article in the Sept. 26 Financial Times headlined “The U.S. Federal Reserve Has Suggested the Build-Up of Bets in the Treasury Market Could Pose a Stability Risk,” sounds the alarm over the fact that high-rolling hedge funds are in the process of taking over that market, turning it into dangerously volatile speculative free-for-all.

In other words, the speculative financial cancer that has been given free rein throughout the trans-Atlantic financial system since August 1971, has now spread to the central nervous system itself.

EIR reported on this same development earlier this year, and on the fact that the Fed’s policy of jacking up interest rates was instrumental in creating this disaster. In its Sept. 26 article, the FT reports that both the Fed and the Bank for International Settlements have over the last month issued warnings about the “rapid build-up in hedge fund bets in the Treasury market.” Back in 2008, the market in Treasuries amounted to about $5 trillion; today it stands at $25 trillion. Furthermore, the so-called primary dealers, the 24 banks that transact directly with the Treasury Department and facilitate trading for investors, have historically been the “market makers” in Treasuries (working with the Treasury to set rates, keep the market steady, and so on); but now the hedge funds are increasingly the market makers, but they are focused on highly leveraged speculative arbitrage, called “basis trade,” which inherently will provoke—and profit from—wild swings in the market.

The FT explains:

“The so-called basis trade involves playing two very similar debt prices against each other—selling futures and buying bonds—and extracting gains from the small gap between the two using borrowed money.... [As a result of] the collision of heavy leverage with sudden and unexpected market movements, and the speed with which that can cause potentially serious problems ... the Fed has said the strategy poses a ‘financial stability vulnerability’ while the BIS [Bank for International Settlements] said it had the potential to ‘dislocate’ trading.”

Various bankers interviewed by the FT spoke in plainer English: “My biggest concern is that if we get a big unwind in this leveraged trade, it could really cause liquidity to dry up in the Treasury market,” said Matthew Scott, head of rates trading at AllianceBernstein. An unnamed senior executive at one of the world’s largest hedge funds told the FT: “If hedge funds stopped buying Treasuries, I don’t know who would buy them.”

The FT does not comment on one additional major implication of this development: What sane country in the world is going to want to keep holding dollar-denominated Treasuries, when that market is taken over by hedge funds that profit on wild speculative fluctuations that they themselves induce?

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