In a market already under pressure, hedge funds are acquiring an increasingly dominant role in US Treasuries, holding positions that now total $2 trillion. Although their presence helps the US find buyers for American debt, the risk stemming from a potential sudden deleveraging has skyrocketed. A massive unwind of leveraged positions could amplify sell-offs, push bond prices lower, and trigger a vicious cycle of volatility and liquidity stress.
Hedge fund holdings in US Treasuries reached $2 trillion at the end of 2025, nearly tripling relative to their level five years earlier, according to a report published last month by the US Department of the Treasury's Office of Financial Research. Tradeable government debt—the debt circulating in the secondary market—stood at $28.9 trillion, bringing the hedge fund share to a record level of roughly 7%.
Recent Federal Reserve data show that hedge funds remained net buyers of US Treasuries during the first half of 2026. Domestic hedge funds purchased a net $60.6 billion in Treasuries during the second quarter, compared to $26.4 billion in the first quarter, pushing first-half purchases to approximately $87 billion. This hedge fund interest arrives at an exceptionally delicate moment for the government bond market, as the 10-year yield surged on Monday to its highest level since 2007, while the 30-year yield jumped on Tuesday to its highest level since 2002.
Risk reaching new heights
"Hedge funds utilize relatively higher leverage compared to other investor categories and, as a result, may amplify systemic risk," said Ricky Siao of Union Bancaire Privée. "When forced deleveraging occurs due to extreme circumstances or crisis conditions, it can lead to a broader liquidity episode and financial instability."
A different breed of buyer
Pension funds were traditionally the primary buyers of long-duration government debt, as their long-term investment horizons allow them to match assets against liabilities extending across decades. However, structural shifts, including the transition from defined benefit plans that guarantee fixed payouts to defined contribution plans whose value depends on investment returns, are dampening pension fund appetite for long-term Treasuries, according to the OECD. This shift comes as several pension funds increase their allocations to higher-yielding, lower-liquidity assets such as private credit. Institutional investors funneled nearly $300 billion into private credit vehicles in 2025, according to Mercer.
Regulators have also highlighted the risks accompanying the growing involvement of hedge funds. The Fed noted in its May financial stability report that hedge fund leverage remained near record levels and was concentrated among large funds, with highly leveraged strategies underpinning substantial positions in US Treasuries and other markets. "High leverage can lead to risk spillovers if a fund suddenly loses access to repo financing," the Fed stated.
Fears over financial stability
The Bank for International Settlements went even further, warning earlier this year that the rise of hedge funds as core intermediaries in sovereign debt markets has created "new vulnerabilities for financial stability." Their reliance on leverage and short-term repo funding could leave core markets more exposed to abrupt deleveraging and operational dysfunction, the BIS noted. Hedge funds do not purchase bonds simply because they find the yield appealing.
"They are very different. Most pension funds and insurance companies have very long investment horizons and focus on liability matching. Hedge funds are interested in performance, typically have shorter horizons, and focus on generating high returns to outperform benchmark yields," said Noah Hamman, founder of AdvisorShares.
The scenario of disorderly deleveraging
A large portion of hedge fund activity involves relative-value strategies aimed at exploiting tiny price differentials between closely linked securities. One of the most widespread is the Treasury cash-futures basis trade, where funds purchase physical bonds while simultaneously selling corresponding futures, aiming to profit from the price divergence between the two markets. Because the spread between cash and futures prices is typically narrow, funds employ substantial leverage to generate attractive returns. Repo market funding allows them to borrow against the bonds and build positions many times larger than their underlying capital.
There are already signs that hedge funds are becoming more selective as the Treasury sell-off intensifies. Leveraged positions in the Treasury basis trade have reportedly dropped by roughly 20% this year to $1.2 trillion, according to Morgan Stanley estimates. This pull-back does not necessarily mean hedge funds are dumping US Treasuries en masse, as Fed data show they remained net buyers through the second quarter. However, the retreat underscores how quickly leveraged positions can shift when market conditions change, highlighting the danger of a disorderly unwind during periods of acute stress.
"The biggest risk is the basis trade, where a hedge fund simultaneously buys government bonds and sells the futures contract into which those specific bonds can be delivered," stated Don Steinbrugge of Agecroft Partners. "These transactions have thin profit margins and can often be leveraged 20 times or more." "As we saw in March 2020, when liquidity in the US Treasury market deteriorated sharply, leveraged funds can be forced to unwind their positions rapidly. This can create a vicious cycle of margin calls, forced selling, and further market volatility."
A sudden spike in volatility can compel leveraged hedge funds to either deposit additional cash as collateral or close out their trades. Such selling pressure can push bond prices lower, widen losses, and force other funds to liquidate their positions as well. Beyond these concerns, experts also point to the constructive role hedge funds play in the government bond market.
Ken Heinz of Hedge Fund Research noted that the willingness of hedge funds to trade actively, rather than holding bonds until maturity dates, provides liquidity in both directions—during rallies as well as sell-offs. This can ultimately help stabilize interest rate movements and curb overall volatility.
The issue, therefore, is not that hedge funds are inherently harmful to the Treasury market. Under normal conditions, their trading activity can enhance liquidity and correct pricing anomalies. "Regulators should be concerned about the potential for disorderly deleveraging while weighing the liquidity benefits hedge funds provide when making policy decisions," Steinbrugge said. "The growing role of hedge funds in the US bond market is simultaneously essential for market liquidity and a potential source of systemic risk."
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